Continuing Education Insurance School
OBEYING THE
ETHICAL RULES
AVOIDING HAZARDS IN MARKETING INSURANCE PLANS
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TABLE OF CONTENTS
Contents
CHAPTER ONE - ANNUITIES ............................................................................................. 1
THE POSSIBLE PROBLEMS WITH ANNUITIES .......................................................... 5
IMMEDIATE vs. DEFERRED ANNUITIES ..................................................................... 5
MARKETING TO SENIOR CITIZENS ............................................................................. 7
SALES PRACTICES IN MARKETING TO SENIORS .................................................... 9
ADVERTISING ............................................................................................................ 10
SPECIAL SENIOR DIFFICULTIES ............................................................................ 11
CLIENT SUITABILITY ................................................................................................... 12
AGENT‘S ADVICE AT TIME OF SALE OF ANNUITY TO SENIORS................... 13
POLICY DETAILS AND NOTIFICATION FOR SENIOR CITIZEN ANNUITIES . 14
ILLUSTRATIONS OF NON-GUARANTEED VALUES ........................................... 14
SEMINARS, CLASSES, INFORMATIONAL MEETINGS ....................................... 15
WAIVERS OF SURRENDER CHARGES................................................................... 15
LIVING TRUST MILLS ................................................................................................... 16
PRETEXT INTERVIEW................................................................................................... 16
MISLEADING MATERIALS ....................................................................................... 17
USING ANNUITIES CORRECTLY AND ETHICALLY ............................................... 18
CHAPTER TWO – ETHICS ................................................................................................. 22
ETHICS AND THE LAW ................................................................................................. 24
JUST FOR FUN ............................................................................................................ 25
ETHICAL THEORY ......................................................................................................... 26
DEFINITION OF ETHICS............................................................................................ 26
ETHICS vs. SUCCESS ................................................................................................. 27
ETHICS AND THE LAW ............................................................................................. 28
WHY A DISCUSSION OF ―ETHICS‖? ........................................................................... 30
EXAMPLE OF BREACHES OF ETHICS - EQUITY FUNDING .............................. 31
IGNORANCE IS BLISS?.............................................................................................. 32
OR GREED? .................................................................................................................. 33
CHARACTER ............................................................................................................... 33
QUANDARIES ............................................................................................................. 34
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ANOTHER DILEMMA – CONFIDENTIALITY OR PROTECT A CHILD .............. 35
TRYING TO RESOLVE DILEMMAS, QUANDARIES OR CONUNDRUMS......... 36
CHAPTER THREE - ETHICAL THEORIES .................................................................... 39
ETHICS OF VIRTUE.................................................................................................... 40
DEALING WITH RIGHT OR WRONG ...................................................................... 41
INTEGRITY .................................................................................................................. 42
HOW DOES THE ACTION AFFECT SOCIETY? ...................................................... 44
IS IT FAIR, JUST AND PROPER? .............................................................................. 44
IS THERE A RIGHTS VIOLATION INVOLVED? .................................................... 44
HAS THERE BEEN A PROMISE MADE? ................................................................. 45
ETHICS IN FINANCIAL PLANNING ............................................................................ 45
EDUCATION FOR FINANCIAL PLANNING ........................................................... 46
CONFLICTS OF INTEREST........................................................................................ 46
THE INVESTMENT ADVISERS ACT OF 1940 ........................................................ 47
DO WE KNOW WHAT ETHICS IN INSURANCE REALLY ARE? ............................ 47
INSURANCE ETHICAL CHOICES - EXAMPLES .................................................... 47
CHAPTER FOUR - VARIABLE ANNUITIES & VIATICALS ...................................... 50
TAKING ANOTHER LOOK AT VARIABLE ANNUITIES .......................................... 50
ADVANTAGES OF VARIABLE ANNUITIES .......................................................... 50
USING VARIABLE ANNUITIES................................................................................ 51
VARIABLE ANNUITIES EXCLUSION RATIO ........................................................ 52
ROLLOVERS (1035 EXCHANGES) ............................................................................... 53
IRS PENALTY .............................................................................................................. 55
VIATICALS ...................................................................................................................... 57
INVESTMENT FRAUD THROUGH VIATICAL SETTLEMENT ................................ 58
BIG BUSINESS! ........................................................................................................... 58
CLEAN SHEETING ..................................................................................................... 58
WET INK POLICIES .................................................................................................... 59
INCONTESTABILITY PERIOD .................................................................................. 59
THE PITCH ................................................................................................................... 60
LIFE EXPECTANCY STATISTICS ............................................................................ 61
REPORTED SCAMS .................................................................................................... 61
"PERSONAL CHOICE OPPORTUNITIES"................................................................ 61
WHAT THIS DOES TO THE LIFE INSURANCE INDUSTRY ................................ 62
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LIFE SETTLEMENTS .................................................................................................. 62
RECENT LEGAL ACTIONS AGAINST VIATICAL COMPANIES ......................... 63
CHAPTER FIVE - DISABILITY INSURANCE ETHICS................................................... 68
THE BACKGROUND OF DISABILITY INSURERS .................................................... 69
HOW CLAIMS WERE AVOIDED .................................................................................. 70
OVERSIGHT REGULATION .......................................................................................... 71
ERISA PREEMPTION ...................................................................................................... 72
ERISA UNLICENSED INSURANCE COMPANIES ...................................................... 73
PHONY ERISA POLICIES .......................................................................................... 74
HOW TO SPOT ERISA SCAMS.................................................................................. 75
OTHER ETHICAL PROBLEMS INVOLVING DISABILITY INSURANCE ............... 76
DEFINITION OF "TOTAL DISABILITY" .................................................................. 77
INTERPRETATION OF THE POLICY ....................................................................... 77
CONCLUSION OF EXAMPLED CASE ..................................................................... 78
CHAPTER SIX – REPLACEMENT, CHURNING AND ILLUSTRATIONS ................... 80
REPLACEMENT .............................................................................................................. 81
CHURNING AND TWISTING .................................................................................... 83
VANISHING PREMIUMS ........................................................................................... 83
CHURNING .................................................................................................................. 83
TODAY'S MARKET .................................................................................................... 87
ILLUSTRATIONS ............................................................................................................ 88
CREDIBILITY OF ILLUSTRATIONS ........................................................................ 88
LIFE INSURANCE ASSUMPTIONS .......................................................................... 89
PROBLEM – THE PUBLIC TRUST ............................................................................ 90
MAKING THE INSURANCE INDUSTRY MORE TRUSTWORTHY ..................... 90
POLICY ILLUSTRATIONS ............................................................................................. 91
REALITY IN PRICING LIFE INSURANCE ............................................................... 93
CONCLUSIONS ............................................................................................................... 93
RECOMMENDATIONS AND ADVISORY NOTATIONS ....................................... 94
REFERENCES ................................................................................................................ 100
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CHAPTER ONE - ANNUITIES
This text will discuss the various reasons that those who market life insurance products, in-
cluding annuities, can find themselves in difficulty with not only their clients, but also their in-
surer and with regulatory bodies. Simply put, this is an ethics manual, but it goes further inas-
much as it will also discuss some common illegal activities. More than anything, this is a "DO
NOT" text and it is hoped that the representative can "stay out of trouble" if they follow these
warnings. Be informed, however, that the field of insurance contains many brilliant marketing
experts that can—and often do—find new "inventive" methods of marketing insurance that may
or may not be ethical and which, frequently, cause to be created new laws, rules &/or regula-
tions.
Therefore, "ethics" per se, are discussed so that when situations arise that may or may not be
ethical (or, sometimes, legal) the individual will (1) recognize an ethical dilemma, and (2) arrive
at an ethical (and legal) solution. Professionalism is stressed, but it has to be acknowledged that
some persons, who market life insurance products, may consider the sale of insurance as a sec-
ondary occupation, therefore, the time necessary to achieve a professional designation—such as
Chartered Life Underwriter (CLU) or ChFC—may not be realistic. However, The National As-
sociation of Insurance and Financial Advisors, which represents many NASD-licensed registered
representatives and registered investment advisors offers advanced training and has its own Code
of Ethics (See last page of this text for a Code of Ethics.)
Please note that this text uses the masculine terms exclusively for purposes of simplicity and
conservation of time. This is certainly not intended to slight those in this industry of the female
gender in any manner.
It should also be noted that this text discusses ethical issues and is not intended as a text on
life insurance or annuities. It is assumed that those who read this text are somewhat versed in
life insurance and annuities, at least so that they can follow the discussion of ethics in marketing
the various products. Characteristics of the products will be discussed in respect to the ethical
problems that may arise because of such characteristics.
Important points will be noted by being boxed and "pointed at" () for emphasis.
"RULES" will also be boxed for emphasis—a "Rule" does not necessarily indicate either a legal
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or an ethical "rule," but is presented as a "suggestion" to the marketer to help avoid legal/ethical
problems so that he will not be tagged as a possible "trouble maker."
To start this discussion, the New York Times very recently ran a story about how unethical
agents were marketing certain kinds of (ethical) annuities to senior citizens. This has caused a
lot of discussion nationwide, and is a good place to start this discussion
From an article in the New York Times, July 8, 2007, by Charles Duhigg
(Names of agents, insurers and clients are not shown as there are continuing legal actions.)
Elderly clients thought they had every reason to trust (the agent involved) as a financial counse-
lor. After all, the … agent had become a "Certified Senior Advisor" in 2002, a credential he made
sure to advertise on fliers sent to retirees. He did not mention how easy it had been to get that title.
(The agent) is one of tens of thousands of financial advisers working hand-in-hand with insur-
ance companies to market themselves to older Americans using impressive-sounding credentials like
Certified Elder Planning Specialist, Registered Financial Gerontologist, Certified Retirement Finan-
cial Advisor and Certified Senior Advisor.
Many of these titles can be earned in just a few days from for-profit companies, and sound simi-
lar to established credentials, like Certified Financial Planner that require years of study, difficult
tests and extensive background checks.
"The degree isn't worth the paper it's written on, "said (an insurance executive) who took the
Certified Senior Advisor exam but does not use the credential. "For many agents," he said, "it's a
scam, a way to put a title on a business card that impresses gullible seniors."
(The agent) had paid $1,095 for a correspondence course, then took a multiple-choice exam
with questions like, "Marketing can be described as" (The answer: "The process or technique of
promoting the sale or distribution of a product or service.") Like more than 18,700 other applicants
since 1997, he passed,
Insurance companies, eager for sales representatives embraced (this agent) as they have thou-
sands of other newly credentialed advisers. The following year, insurers paid him commissions
worth $720,000 as his business with retirees soared. But many of those sales same from steering
older Americans into unwise investments, (state) regulators contend in a lawsuit.
(The agent denied all wrongdoing), but one of his clients, a 73-year-old widow caring for a son
with Down syndrome—said he tricked her into buying complicated insurance contracts that left her
unable to pay dental and home-repair bills.
"His office was filled with things saying he was certified to help seniors," said (that client) "The
only one he really helped was himself."
Many graduates of these short programs say they only want to help older Americans. But they
are frequently dispensing financial counsel they are unqualified to offer, advocates for the elderly say.
And thousands of them are paid by some of the largest insurance companies … to sell elderly clients
complicated investments that economists say most retirees should never own.
The price for these insurers and sales agents is the $15 trillion held by Americans 65 and older,
the largest pool of assets ever amassed by an aging population, according to the Government Ac-
countability Office.
"The insurers are happy to turn a blind eye to what salesmen are doing," said Minnesota's attor-
ney general … who is suing several companies … contending their products are inappropriate.
(Three insurance companies) whose revenues last year were a combined $163 billion, said they
investigate the backgrounds of all agents, screen al sales to consumers to make sure they are appro-
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priate, and have terminated representatives using improper sales methods. Those companies said
they were not aware of abusive methods taught at any seminary they endorsed.
In a statement (one of the companies mentioned) said that company did not tolerate misrepre-
sentation. "(It) is a leader in education opportunities and quality for agents," the statement reads.
Fewer than half of one percent of its customers have every complained, according to the company.
(Another company), in a statement, said any evidence of sales agent misconduct, without excep-
tion, results in immediate termination.
Nonetheless, complaints over sales of insurance products have soared. In particular, grievances
have stemmed from annuities, which are insurance contracts that offer buyers monthly or yearly in-
come in exchange for one large lump-sum payment and are designed to appeal to anyone worried
they might outlive their savings.
More than one-third of all cases of financial exploitation of the elderly involve annuities, ac-
cording to the North American Securities Administrators Association, a group of regulators. Hun-
dreds of lawsuits have been filed against insurers over annuity sales to the elderly.
A judge in Minnesota ruled this year that just one class-action suit … could encompass as many
as 400,000 plaintiffs.
In interviews, sales agents who have been accused of wrongdoing said they followed the guid-
ance of insurance companies. "I did what I was told," said (the agent mentioned in this story) be-
fore declining to further discuss the charges against him. "If it was so wrong, why did everyone let
me do it for so many years?"
Annuities are among the insurance industry's fastest growing products, with sales increasing 30
percent since 20101, to $182.8 billion last year, according to the Insurance Information Institute.
Regulators say annuities that begin paying immediately are often sold as investments for reti-
rees. A 73-year-old customer of one popular annuity, for instance, is guaranteed to begin imme-
diately receiving $252 a month for life, in exchange for a $30,000 payment. If the buyer lives more
than 10 years, that income is greater than original amount paid.
But the vast majority of annuity sales do not offer immediate payouts. Instead, they require
purchasers to wait as long as 10 years to begin receiving benefits. Such contracts, known as deferred
annuities, made up 97 percent of all annuity sales last year.
Financial experts say deferred annuities are a good option for wealthy investors looking for
ways to transfer wealth to their heirs while avoiding large tax payments. But for retirees living off
their savings, most deferred annuities are a bad choice, say experts, because elderly buyers are likely
to die before the contract begins paying out.
Deferred annuities, however, offer sales agents the richest commissions, which is why so many
of them are sold every year, regulators say. Selling a $100,000 Deferred Annuity, for example, typi-
cally earns a sales representative $9,000, though buyers are prohibited from touching much of their
money for 10 years. Annuities with shorter tie-ups carry much smaller commissions.
Before (an elderly widow) accepted invitation to one of (the agent's) seminars in 2002, she had
never balanced her checkbook. Her husband dies of colon cancer six months earlier. Though she
had raised five children, including a son with Down's syndrome, she knew almost nothing about her
family's finances. (The widow) asked (the agent) to handle her $75,000 savings.
(The agent) transferred (her) savings into deferred annuities sold by (an insurer). Those con-
tracts, which were impossible cancel without paying large penalties, prevented (her) from receiving
the annuity's payouts for five years, unless she paid significant fees.
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In October, (her) dentist told her she needed a $3,200 bridge replacement. Repairmen said she
needed a new furnace and gutter work that would cost a combined $6,500.
She contacted (the insurance company) and explained she had never intended to buy the annui-
ties.
"I am 72 years old and need access to my money now," she wrote. She wrote the contracts
were never fully explained to her, a claim (the agent) denies.
(The insurer) initially denied her request. An executive gold her they were siding with (the
agent's) account that the annuities were sold properly.
When (the insurer) learned that the (state) regulators had sued (the agent) in March, the compa-
ny cut its ties to him and refunded (her) money.
(The widow) said her complaints alone should have spurred the company to action.
"How many other seniors have been tricked into these things but are ignored when they com-
plain?" she asked.
And if that isn't enough, on September 5, 2007, under the headline
"Investment pitches target elderly"
A related story starts out:
Less than a year before he died, an ailing, wheelchair-bound Arthur Moyer converted his
$500,000 life savings into a complex investment he could not tap for a decade without incurring
steep fees. [Guess what kind of investment!!]
"The 79-year-old former machinist from Pennsylvania poured his money into a Deferred
Annuity at the urging of a salesman who collected a hefty commission and presented himself as a
retirement expert… …Moyer spent the final weeks of his life fending off depression."
There was good news, though, on the day he was buried the insurance company agreed to
unwind the deal and return his life savings. He was buried with a copy of that letter in his coat
pocket.
The remainder of the story closely follows the previous story; just change the faces and the
places. One little tidbit that was not mentioned before, when the state and federal regulators in-
vestigated this situation, they discovered that third-party marketing companies are creating im-
pressive investment advice booklets that are sent out to retirees as lead generation, but the book-
lets are not written by the agent, as the booklet represented, but by a company that makes them
and then sells them to the agents.
RULE: DO NOT TARGET THE ELDERLY FOR INVESTMENT PRODUCTS AND
REPRESENT YOURSELF TO BE A FINANCIAL ADVISOR UNLESS YOU ARE
FULLY QUALIFIED AS A FINANCIAL ADVISOR AND ARE WELL ACQUAINTED
WITH STATE AND LOCAL REGULATIONS REGARDING MARKETING TO THE
ELDERLY.
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THE POSSIBLE PROBLEMS WITH ANNUITIES
In order to better understand "ethics" in marketing life insurance and annuity products, plus
the legalities that can affect the marketing, a good place to start is with a discussion of annuities.
There are several reasons for this:
annuities are easily misrepresented, while simple in concept they can be full of hidden
opportunities for misrepresentation;
some annuities are "insurance" products only, others are "securities," while others
have the features of both;
the plans may be sold by dually-licensed agents (which can mean that securities deal-
ers are not familiar with the "insurance" type, while insurance agents are not familiar
with the "securities" aspect);
and certain annuities are designed to be sold to the older population (while others are
designed to be sold to the younger folks).
On the other hand, annuities that are properly sold to the correct market have been around for
years and many of the retired population are happily receiving checks monthly from an insurance
company—in effect,
with an annuity a person cannot "outlive" his assets.
The safety of their funds is perhaps the most important factor in annuity sales as most ver-
sions are backed by the assets of a large insurance company with unimaginable billions of assets,
allowing the annuity holder to sleep at night knowing that regardless of flood, hurricane winds or
famine, his check will be in the mailbox (or credited to his bank account) every month.
RULE: ALWAYS MAKE SURE THAT THE INSURANCE COMPANY IS
SOLVENT AND WILL BE AROUND WHEN THE ANNUITANT ANNUITIZES!
This will be discussed in more detail later, but some of the older agents may remember when
Baldwin United Life Insurance Company sold millions of dollars in annuity premiums, and then
went bankrupt. Widows and widowers and retired folks by the thousands were in near hysteria
until the Departments of Insurance and the solvency fund stepped in. While it is true that many
annuitants received less that they expected, the insurance departments, working together, were
able to place the annuities with larger, solid companies (such as Metropolitan Life Insurance
Co.). The end result was that the annuitants eventually received what they had expected.
IMMEDIATE vs. DEFERRED ANNUITIES
In order to understand the ethical problem with marketing an annuity to an elderly person,
one must realize that an Immediate Annuity is very often and effectively written on elderly per-
sons who have large sums of money that they want to receive as income while they are still alive.
There is generally no problem with marketing an Immediate Annuity to, say, a 65 year-old re-
tired person who has a large sum of money from, for instance, an employee bonus program (or
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maybe he got lucky with the horses…) and wants money from these funds to supplement his So-
cial Security and/or retirement plan.
Deferred Annuities are different as they are designed to accumulate funds that usually are
paid in to the insurance company as annuity premiums on a monthly basis. Based on the age of
the annuitant the premiums paid in, and the length of time that the premiums are paid before the
annuity "annuitizes," (i.e., benefits start being paid out) determines how much money the annui-
tant will receive each (usually) month. Without going into all the details, Deferred Annuities
have a special and respected place in retirement planning.
Now, remember the widow who invested her money at age 72 (and who had never handled
her own checkbook) into a Deferred Annuity and who needed money NOW. There are several
rules that are important and that are in play here.
RULE: DEFERRED ANNUITIES ALMOST NEVER SHOULD BE SOLD TO A
PERSON OVER AGE 70.
Sure, there are exceptions, but if there are such exceptions realize that you are treading on
thin ice. For instance, if the person is wealthy and has a financial advisor (CPA or such) that ful-
ly understands the product and can also explain it to the prospect, and who is not investing all of
their funds into the product, then it may be relatively safe. And the age is not engraved in stone,
in some cases Deferred Annuities should not be sold to a person over 60 or 65.
Is this is a common problem? What happens is that the senior citizen just does not under-
stand that if the annuitant wants to withdraw funds prior to its annuitization date, there will be a
penalty. And the penalty will probably be big. This also means, ethically:
RULE: DEFERRED ANNUITIES SHOULD NOT BE SOLD TO PERSONS WHO
MAY HAVE AN IMMEDIATE NEED FOR CASH.
How do you know if they will have an immediate need for cash? Ask them! Over and over
again until you (ethically) agree that, they will in all likelihood, never need to withdraw funds
from the annuity.
Ethical dilemma can arise here: As an illustration—
Agent Joe has discussed a Deferred Annuity with his client and friend of several years,
Bill, and when Bill sold his bar when he was 55, Bill told Joe that "now is the time for
an annuity."
Joe, being a friend, knew that Bill's wife was just waiting for him to sell his bar so that
she could run off with her body-builder boyfriend. Or, perhaps, Joe knew that Bill was
not a good money manager and he had 3 kids, two in college and one in High School.
Bill had put aside some money for their education, but Joe asked how much was in the
fund as he Joe was certain that the fund was inadequate for the education of the children.
Joe was also the P&C agent and knew that there was still a mortgage on the house and
because of where the house was located; the homeowner's premiums were going up each
year.
In essence, Joe was personally convinced that Bill was going to need some of the money
that he was going to put into the annuity, relatively soon. Joe explained, carefully and
fully, the impact of the penalties for early withdrawal, but it seemed not to make an im-
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pression on Bill. He knew that he was not a good money-manager, so he just wanted to
be rid of the money and as he said, "put the monkey on the insurance company's back"
to make sure that he had some money when he reached 65.
What does Joe do? Can he, ethically, write the annuity that Bill requested, or can he just
tell Bill, "I am sorry, but as a friend and as your agent, this is a mistake for you to put all
of your funds into a Deferred Annuity at this time." Bill says, "OK, then I will go to
Agent Ron who has wanted my insurance business for a long time, and he will also re-
write all of the insurance that you presently handle into another company."
This is a typical ethical situation in insurance. In these kinds of situations, what does the
agent do?
The Code of Ethics of the American College (CLU, ChFC and CPCU) contains two ethical
imperatives which mandate that
A member must provide competent advice which is in the client's best interest.
Many scholars believe that the Golden Rule (do unto others …) is the basic, driving force
behind all ethics. Maybe so, but for the insurance agent—and in particular, the professional—
insurance agent, the above rule should be inscribed in granite, posted on the courthouse steps,
and tattooed on the forehead of all new agents —or at least remembered and USED.
RULE: TO STAY OUT OF TROUBLE, PROVIDE COMPETENT ADVICE WHICH
IS IN THE BEST INTEREST OF THE CLIENT.
(This rule is important enough to show it twice).
Did the agent provide competent advice to the 72 year-old widow in the article? Of course
not! Ditto the 79-year old very ill customer.
Does the agent have a legitimate alibi that the insurance company had never said anything
about selling these annuities to senior citizens before? This is like saying, "I never robbed the
bank, officer, I just drove the getaway car." The insurance company may share some of the
blame (this will be discussed later) but that does not alleviate, in the least, the unethical behavior
of the agent.
MARKETING TO SENIOR CITIZENS
California regulations may be the most stringent in the country and as such, are important be-
cause marketing of insurance products to Senior Citizens has been of concern to all Insurance
Departments for some time, and some have also taken rather stringent steps. California regula-
tions may be harbingers of tightening of the rules involving marketing insurance to the elderly
and as such, are worth of our consideration. For instance, the California Department of Insur-
ance requires that:
"All individual life insurance policies and individual annuity contracts for senior citizens that
contain a surrender charge period shall either disclose the surrender period and all associated pe-
nalties in 12-point bold print on the cover sheet of the policy or disclose the location of the sur-
7
render information in bold 12-point print on the cover of the policy, or printed on a sticker that is
affixed to the cover page or to the policy jacket. " (10127.12 California Insurance Code [CIC])
The CIC also says:
"(a) All insurers, brokers, agents, and others engaged in the transaction of insurance owe a
prospective insured who is 65 years of age or older, a duty of honesty, good faith, and fair deal-
ing. This duty is in addition to any other duty, whether express or implied, that may exist.
(b) Conduct of an insurer, broker, or agent, or other person engaged in the transaction of in-
surance, during the offer and sale of a policy or certificate previous to the purchase is relevant to
any action alleging a breach of the duty of good faith and fair dealing. (CIC Section 785)
And, if you think that this is tough, for those not familiar with California regulations, the fol-
lowing regulation is one of the strictest in the country and it is fair to say that eventually nearly
all, if not all, states will follow suit.
"(a) this section applies to the sale; offering for sale, or generation of leads for the sale of life
insurance, including annuities, to senior insureds of prospective insureds by any person.
(b) Any person who meets with a senior in the senior's home is required to deliver a no-
tice in writing (our emphasis) to the senior no less than 24 hours prior to that individual's indi-
vidual meeting in the senior's home. If the senior has an existing insurance relationship with an
agent and requests a meeting with the agent in the senior's home the same day, a notice shall be
delivered to the senior prior to the meeting. Such notice shall be in substantially the following
form, with the appropriate information inserted, in 14-point type:
"(1) during this visit or a followup visit, you will be given a sales presentation on the fol-
lowing (indicate all that apply):
( ) Life insurance, including annuities
( ) Other insurance products (specify): _________________.
(2) You have the right to have other persons present at the meeting, including family
members, financial advisors or attorneys.
(3) You have the right to end the meeting at any time.
(4) You have the right to contact the Department of Insurance for information, or to file a
complaint. (The notice shall include the consumer assistance telephone numbers at
the department)
(5) The following individuals will be coming to your home: (list all attendees, and insur-
ance license information, if applicable)"
(c) Upon contacting the senior in the senior's home, the person shall, before making any state-
ment other than a greeting, or asking the senior any other questions, state that the purpose of
the contact is to talk about insurance, or to gather information for a followup visit to sell in-
surance, if that is the case, and state all of the following information:
(1) The name and titles of all persons arriving at the senior's home.
(2) The name of the insurer represented by the person, if known.
(d) Each person attending a meeting with a senior shall provide the senior with a business card or
other written identification stating the person's name, business address, telephone number,
and any insurance license number.
(e) The persons attending a meeting with a senior shall end all discussions and leave the home of
the senior immediately after being asked to leave by the senior.
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(f) A person may not solicit a sale or order for the sale of an annuity or life insurance policy at
the residence of a senior, in person or by telephone, by using any plan, scheme, or ruse that
misrepresents the true status or mission of the contact. (CIC 789.10)
Why, do you suppose, such stringent regulations regarding marketing to Seniors was neces-
sary in California? The answer is, obviously, that agents that operated in that market were uneth-
ical. These types of regulations are inevitable after an Insurance Department receives complaints
as to how they were treated by agents, particularly from senior citizens. If the agents in Califor-
nia had operated ethically, then these tough regulations would not exist.
Look at the regulation and see where it requires what would otherwise be, an ethical act.
Shouldn't every agent make sure that the prospect knows who he is, why he is there and what he
is selling? While the 24-hour notice before a senior can be approached may seem a little over-
the-top at first blush, this allows the senior to contact family members or others upon which they
rely, to be notified that the agent will be visiting him shortly and what it is all about. Everything
else in this regulation should have been performed anyway.
RULE: WHEN MARKETING TO SENIORS, ABIDE BY THE INSURANCE CODE
OF CALIFORNIA—IN OTHER STATES, ACT AS IF YOU WERE IN CALIFORNIA.
SALES PRACTICES IN MARKETING TO SENIORS
It would be nice if there were no such thing as an ―unethical‖ agent, but unfortunately this is
not the case. Therefore, regulations are in force to correct the practices that cause irreparable
harm to our industry and to our profession, as noted above in California. The most often targeted
of our population by these miscreants are the elderly for a variety of reasons. Fortunately, the
various state's Department of Insurance and their legislatures have created special types of regu-
lations for the protection these citizens, particularly true in respect to annuity sales. This section
discusses the sales practices of agents marketing annuities to anyone regardless of age, recogniz-
ing that this particularly applies in of marketing to the seniors.
Contacting a senior citizen for the purpose of selling insurance or annuities as the result of a
―lead system‖ is not illegal as such, provided that there is no misrepresentation, of course. For
any such advertisement or any other lead method that is directed towards those ages 65 or older,
regulations generally provide that it shall prominently disclose that an agent may contact the ap-
plicant (if that is the case). And further, the agent who contacts that person as a result of the lead
MUST disclose that fact to the prospective purchaser during the initial contact.
It is also illegal in most states for an agent or broker or solicitor, etc., to solicit a person age
65 or older for the purpose of marketing annuities (or life insurance or disability insurance) by
using a business name, whether true or fictitious, which is deceptive or misleading in respect to
the status, character, or proprietary representative capacity of the entity or person, (and here is
the ―kicker:‖) or to the true purpose of the advertisement. Even where this may not be illegal, it
certainly is, at least, unethical. Regulations in some states have gotten so severe that the insur-
ance code also defines an advertisement as envelopes, stationery, business cards, or other mate-
rials designed to encourage…(an) annuity. For instance, the business card or other price quotes
or advertisements must contain the agent‘s license number and word ―Insurance.‖
9
ADVERTISING
For the purpose of this discussion and regulations, ―advertising‖ applies not only to ads, bro-
chures, newspaper and other media articles, television and radio advertising – but primarily
printed material. Envelopes, stationery, business cards and any other material that is used by an
agent or insurer that are designed to describe the insurance product and to attempt to encourage a
purchase of the insurance product – annuity for this discussion.
Simply put, the regulations are intended to insure that the insurers and agents treat their
clients honestly and openly. If such regulations are not inexistence, then ethics must suffice (or
regulations will follow).
RULE: ANY ADVERTISING MUST NOT MISLEAD THOSE WHO READ IT AND
ACT UPON THE INFORMATION CONTAINED IN THE MATERIAL.
A lot of the problems can be avoided by just using "common sense." If the advertisement
hints that the annuitant (particularly a Variable annuitant) will enjoy an asset growth at an 8%
rate in the current market, and whether it comes right out and says it or in some fashion sublimi-
nally—such as an advertisement showing a retirement home or whatever, but in the background
is a representation of a balance sheet that indicates at least an 8% growth—is not only unethical,
illegal in most states, but is just plain stupid.
When advertising an investment product, never indicate or show ANY per-
centage of growth because, as soon as you do, it then becomes "engraved in stone."
Advertising is also the material that is used to generate leads through reader response, gener-
ally followed by an agent calling. It can advertise a meeting or seminar at which information is
provided (also covered in detail in a separate section), or simply advertising the product of the
insurer. If the advertisement is directed towards those age 65 or older and if the advertisement is
used for leads, in most states the advertiser must disclose in the advertisement that an agent may
contact the person – if this is intended.
If the name of the prospect is obtained from a lead source, the source must be disclosed in
some states (California for instance) and should be disclosed everywhere to those over age 65. A
senior can get rather upset if they think someone is trying to get them involved with something
that they know nothing about.
Even though it is in nearly all agents' contracts, it does not hurt to point out that the insurance
company must give an agent permission in writing before the agent can advertise the product.
EXEMPTIONS FROM ADVERTISING REGULATIONS
While the regulations are quite specific in respect to requiring that every licensee shall prom-
inently affix, print or type on business cards, price quotes or advertisements, its license number,
address or fax number, and the word, ―Insurance‖ must be displayed (as stated above) on the
printed matter, there are certain exception, one of which is that Life Insurance policy projections
and illustrations, or to life insurance cost indexes as required by other regulations, are exempt,
but they must comply with other appropriate regulations.
10
LOANS
If an agent persuades or causes a client to cosign or make a loan, investment or gift, or pro-
vide a future benefit through a right of survivorship for the benefit of
the agent,
a person with a relationship to the agent by birth, marriage or adoption,
a friend or business acquaintance of the agent, or
domestic partner of the agent –
the agent’s license may be suspended or revoked, in all jurisdictions.
Normally, this would not apply if the client is related to the agent by birth, adoption or mar-
riage; or is a domestic partner of the agent.
AGENT BENEFICIARIES
The agent‘s license may be suspended or revoked if an agent persuades or causes a client to
designate as a trust beneficiary or beneficiary or owner of a life insurance policy or annuity for
the benefit of the agent, a person with a relationship to the agent by birth, marriage or adoption, a
friend or business acquaintance of the agent, or a domestic partner of the agent. This does not
apply if the client is related to the agent by birth, adoption or marriage, or is a domestic partner
of the agent.
AGENT TRUSTEE
The agent‘s license may be suspended or revoked is the agent persuades or causes a client to
designate as a trustee under a trust, the agent, etc., as listed above. There is an exception where
the agent is designated as a trust or a testamentary or inter vivo trust if the agent is also an attor-
ney in any state and the agent is not a seller of insurance to the Trustor of the fund.
AGENT HOLDING POWER OF ATTORNEY
An agent‘s license may be suspended or revoked if an agent has a power of attorney for a
client and has sold the client an insurance product for which the agent has received a commis-
sion. Further, the license may be suspended or revoked if the agent has used the power of attor-
ney to purchase an insurance product on behalf of the client and for which the agent has received
a commission. This is the rule in nearly all states, and, of course, it does not apply if the client is
related to the agent by birth, adoption or marriage, or is a domestic partner of the agent.
SPECIAL SENIOR DIFFICULTIES
The senior citizens have special difficulties in the purchase of insurance, annuities and other
financial matters. Perhaps the most critical problem they have is the simple fact that short-term
memory loss is typical as one grows older. Therefore, this important part of our society must
have special protection against those who would take advantage of these conditions suffered by
our seniors. Most states have recognized this problem and have enacted regulations to assist in
the marketing of insurance and other financial products to elder citizens. These regulations are,
in effect, the result of unethical situations that have been so abused that they are now regulations.
So, even if there are no specific regulations, follow the previous RULE that requires an agent in
any state to operate as if he were in California. In this respect, it would not hurt to look at CIC
Section 38.
11
"A person without understanding has no power to make a contract of any kind, however, the
person is liable for the reasonable value of things furnished to the person necessary for the sup-
port of the person or his/her family." (CC Code Section 38)
(CC Code Section 39): "(1) A contract or other conveyance of a person of ―unsound mind‖
but with some understanding, that was made prior to the incapacity of the person has been de-
termined by the courts, is subject to rescission. Further (2) there will be a rebuttable presump-
tion that affects the burden of proof that a person is of unsound mind if they are substantially
unable to manage his/her own financial resources, and also be able to ―resist fraud or undue in-
fluence.‖ Substantial inability cannot be proven only by an isolated incident of negligence or
―improvidence.‖
(CC Code Section 40): , referring to the appropriate Probate Court and the Welfare and Insti-
tutions Code, states that after his/her incapacity has been officially determined by a court, a per-
son of unsound mind may make no conveyance or other contract, delegate power or waive any
right, until they have been fully restored ―to capacity.‖ Further, the establishment of a conserva-
torship (under the proper Probate Code) must be determined by the courts of the incapacity of the
―conservatee.‖
(CC Code Section 41) states that a person of unsound mind, regardless of what degree, is
still civilly liable for a wrong that they commit, but is not liable in exemplary damages unless at
the time of the act, the person was incapable of knowing that the act was wrongful.
CLIENT SUITABILITY
Selling annuities to a senior is a financial product sale, and an effort must be made to make
sure that the client and product suit each other. It is extremely important that detailed financial
records be kept of all transaction with the seniors as; typically, some of the material discussed
will be forgotten otherwise. And before financial discussions can be meaningful, it is necessary
for the senior client to have detailed financial records of his assets and liabilities.
The tax situation of the client is important as that is one of the most important benefits of an
annuity, however, if the client really has little or no income tax liability and none is anticipated,
then serious consideration must be given as to whether (a) this is the proper product for the
client, and (b) if the client can afford the financial strain of investing in an annuity.
In the same vein, as mentioned earlier, since annuities are not designed to be effective short-
term investments, if the client does not have sufficient liquidity to maintain a decent life style
after purchasing an annuity, then it could be entirely possible that an annuity is not suitable. If it
appears that the client may need or want the funds that are invested in the annuity, in the near
future, then other types of investments or products should be used, not an annuity. The surrender
charges and taxation penalties for short-term investing in annuities must be fully explained so
that the client understands that if he purchases the annuity for short-term needs, it can be quite
costly.
In discussing financial needs, the client will probably have some investments already in a
401(k) or 403(b) plans, Keogh plans, or some other such retirement plan, unless he has already
distributed these funds because of age. If the client still qualified for any of these plans that offer
favorable tax benefits, then that is where his money should go at this time. If, on the other hand,
an annuity is purchased for the purpose of funding a 401(k) or similar account, then the tax bene-
fits of an annuity is unnecessary and the annuity should be used in a tax-qualified account only in
12
those situations where the tax–deferral is important.
If a senior is thinking of buying a Variable Annuity, then it is the legal and ethical duty of the
agent to look at the investment sophistication of the client, as this is a rather complex product.
Sometimes the concept of variable subaccounts, in particular, is beyond the contemplation of the
senior. Unless the client is so wealthy that he would not notice how the market fared because the
money was immaterial, then an agent is not performing a professional (ergo, ethical) service if
the client does not fully understand how the plan works.
If the client cannot understand fully the ramifications of the annuity purchase, there will not
be the type of situation that makes for a happy relationship. If the client does not provide enough
information so that a proper determination as to the suitability of the product can be made, then
that is also not a good situation.
If the client makes a decision that is against the recommendation of the agent
or insurer’s recommendations, the consequences of such an action must be fully unders-
tood by the client – but it is his decision to make and a professional will provide as much
assistance as possible so that his decision would not cause too much damage, if any.
This has led to interesting ethical dilemmas at times, as also mentioned earlier in the exam-
ple. There are those who insist that the only ethical response is to walk away, which is a consid-
eration.
An ethical dilemma must have two or more solutions.
(This is getting just a little ahead as the fundamentals of ethics are yet to be discussed; how-
ever, the above is basic to these discussions.)
If these recommendations are suitable, the insurer (and the agent) must
maintain adequate records so that in the future at any time, after the fact, it can be deter-
mined if the recommendations were suitable for that client.
This is basic "business," but it is important, and not only as a CYA (cover your actions) safe-
guard.
AGENT’S ADVICE AT TIME OF SALE OF ANNUITY TO SENIORS
Many states have regulations in respect to sales of annuities to Seniors that state that if an
(life insurance) agent offers to sell an ―elder‖ any life insurance or annuity product, the agent
must advise the elder or the elder‘s agent that the sale or liquidation of any stock, bond, IRA,
Certificate of deposit, mutual fund, annuity, or other asset to fund the purchase of this product
may have tax consequences, early withdrawal penalties, or other costs or penalties as a result of
the sale or liquidation. Further, the agent must advise his client that he/she or elder‘s agent, may
want to consult an independent legal or financial advisor before selling any assets or before sell-
ing or liquidating any annuity product being sold, offered for sale or even being solicited.
13
POLICY DETAILS AND NOTIFICATION FOR SENIOR CITIZEN
ANNUITIES
More and more states are requiring that annuities sold to Seniors over age 60 must have a no-
tice which plainly states that after he has received the annuity it may be returned to the insurer
for cancellation simply by mailing or delivering it to the company or to the agent from whom it
was purchased. The annuity owner may return the annuity within 30 days by mail or otherwise
during this period. For a Variable Annuity the premium may be invested only in fixed-income
investments and money-market funds, unless the investor specifically directs that the premium
be invested in the mutual funds underlying the Variable Annuity contract.
If the Variable Annuity is returned within the 30-day cancellation period and if the owner has
not directed that the premium for Variable Annuity contracts be invested in the mutual funds un-
derlying the contract during the cancellation period, then this will have the effect of voiding the
policy – which means that the parties shall be in the same position as if there had been no policy
issued and all premiums paid and any policy fee paid for the policy shall be refunded by the in-
surer to the owner within 30 days from the date that the insurer is notified that the owner has
canceled the policy.
These are regulatory measures, but they must be pointed out directly and specifically to the
annuitant.
Conversely, if the owner of a Variable Annuity has directed that the premium be invested in
the mutual funds underlying the contract during the 30-day cancellation period, then it follows
that cancellation shall entitle the owner to a refund of the account value which will be refunded
within 30 days from the date that the insurer is notified that the owner has canceled the contract.
ILLUSTRATIONS OF NON-GUARANTEED VALUES
Illustrations create their own particular problems and will be addressed later, however some
states—California is one—that takes it another step. When non-preprinted illustrations of non-
guaranteed values on annuity contracts that are delivered or issued for delivery to senior citizens
it shall disclose on those sheets, in bold or underlined capitalized print, or in the form of a con-
trasting color sticker, bright highlighter pen, or in any manner that makes it more prominent than
the surrounding material, with at least one-half inch space on all four sides, the following state-
ment:
"THIS IS AN ILLUSTRATION ONLY. AN ILLUSTRATION IS NOT INTENDED TO
PREDICT ACTUAL PERFORMANCE. INTEREST RATES, DIVIDENDS, OR VALUES
THAT ARE SET FORTH IN THE ILLUSTRATION ARE NOT GUARANTEED, EXCEPT
FOR THOSE ITEMS CLEARLY LABELED AS GUARANTEED."
This is a good idea, even if it is not required by regulation.
14
SEMINARS, CLASSES, INFORMATIONAL MEETINGS
The ―seminar‖ approach to selling is addressed in this discussion of marketing annuities, as if
one lives in a retirement community and if they are over age 55, they will be deluged with invita-
tions to attend an ―educational seminar,‖ often at one of the trendiest luncheon spots in the city,
for the purpose of discussing ―estate planning,‖ ―investment strategy‖ or ―Long Term Care Plan-
ning‖ or such.
Agents and others, who market financial products, sometimes attempt to obtain new clients
by holding seminars, classes or information meetings. This is particular applicable in the Senior
market and basically, where such is regulated, the regulations require that for such a meeting to
be advertised (to any age) that the advertiser must disclose their intention by adding ―and insur-
ance sales presentation‖ immediately following the words ―seminar,‖ ―class,‖ or ―informational
meeting.‖ And where there are no such regulations, consider whether it is ethical to hold a "se-
minar" or whatever it is called, strictly for the purpose of selling an insurance product, without
notifying those who are being solicited that this "seminar" is really just a sales presentation of an
insurance product. Misrepresentation, you think? Misrepresentation is unethical, in case there is
any question about it.
So, what is wrong with this? Sometimes, not a thing. The speakers may be professionals in
their field and include attorneys specializing in elder law, tax accountants or attorneys specializ-
ing in taxation, but in every case someone is trying to sell something (somebody has to pay for
the meal or hall rental). The problem generally is that the person who is selling something often
misrepresents him (or her) –self as an ―expert‖ in the field, and/or they do not advertise that the
sole purpose of the ―seminar‖ is to sell insurance or annuities (or mutual funds, etc.).
This can be a violation of the insurance code on untrue, deceptive or misleading advertise-
ments as no advertisement (even an engraved personalized invitation is still an ―advertisement)
for an event where insurance products will be offered for sale, may use the terms ―Seminar,‖
―Class,‖ ―Informational Meeting,‖ or similar term to characterize the purpose of the event unless
it adds the words, “and insurance sales presentation” immediately following those terms in the
same type size, etc. Such meetings are obviously not illegal per se, unless they are used to sell
insurance products without prior notification.
WAIVERS OF SURRENDER CHARGES
Surrender charges have been discussed and is a problem with those who purchased an annui-
ty and for-whatever-reason finds that they need to take the money out of the annuity. Until re-
cently, the only way an annuity owner could take out the money without paying a penalty - often
substantial – was at death and, of course, at annuitization. Now, however, surrender charges are
waived on most annuity policies if the owner is confined to a nursing home.
Some policies go a little further and will also allow surrender without penalty in cases of
terminal illness or hospital confinement's disability, even ―disaster‖ in some annuities (often re-
ferred to as ―crisis waivers).
The waiver of surrender charges may be accomplished either by waiver or by rider. The dis-
tinctions between ―waiver‖ and ―rider‖ are often blurred, but basically the waiver is the volunta-
ry relinquishment of a legal right, and a rider is an attachment or endorsement to a policy that
15
modifies clauses or provisions of a policy. Even when used interchangeably, usually the waiver
is instigated by the insurance company and often no extra charge is accessed against the policy-
holder, whereas a rider is instigated by the insured and there often is an added charge.
LIVING TRUST MILLS
For purposes of this discussion, a ―Living Trust Mill (LTM)‖ is an unlawful (and unethical
where there are no specific regulations per se) marketing scheme used to sell annuities to senior
citizens. While there actually are several types of LTMs, they are all are created by misrepresen-
tation of identity and purpose as each ―mill‖ misrepresents the actual business of the sales repre-
sentative and hides the true purpose of the solicitation. Often the first approach to seniors is the
―seminar‖ approach, as discussed above, but instead of presenting the product of service that
they advertise, the meeting is supposedly designed to educate those attending about the benefit of
living trusts (and other estate planning devices). Seniors are invited through mass mailing, tele-
marketing, or any other method to ―get the word out‖ including informal announcements at se-
nior functions.
Once the crowd has gathered, the salespeople misrepresent themselves as experts in financial
and/or estate planning. Their services are either very inexpensive or ―free‖ as a public service,
but in any event, the goal is to get the trust of the seniors and they find out the assets of the se-
niors by determining whether the senior could benefit from a living trust.
Persons so engaged in these ―mills‖ may be licensed or unlicensed insurance persons and
they may work in conjunction with attorneys, thereby giving a ―legalistic‖ atmosphere to the
meeting. After the living trust and other estate planning documents have been sold, then a li-
censed agent – who in most cases does not represent himself/herself to be an ―insurance agent‖ –
tries to sell the senior on the benefits of an annuity as part of the estate planning process. Actual-
ly, clients often will consider the agent as their legal advisor or estate planner and not an insur-
ance agent.
Besides being actionable under the Business and Professional Code in the various states, such
violations are administratively actionable under the Insurance Information and Privacy Protec-
tion Act (CIC Section 791 and sequential portions) and may result in cease and desist orders, fi-
nancial penalties and suspension or revocation of certificates of authority and/or insurance li-
censes.
BIG RULE: NEVER, EVER, UNDER ANY CIRCUMSTANCES, BECOME
INVOLVED IN SUCH A TRUST MILL.
PRETEXT INTERVIEW
The California Code states that ―no insurance institution, agent or insurance support organi-
zation‖ (defined as persons engaged in business of collecting information about persons for the
primary purpose of providing the information to an insurance institute or agent for an insurance
transaction…) shall perform a pretext interview." Be informed that this regulation may not be
defined as a "regulation" in another state, but the chances of a highly unethical pretext interview
not being prosecuted in other states is infinitesimal.
16
RULE: JUST BECAUSE A SITUATION IS ADDRESSED BY THE INSURANCE
CODE OF ONE STATE AND NOT IN OTHERS STATES, DOES NOT MEAN THAT IT
WILL NOT BE ENFORCED UNDER ANOTHER NAME IN ANOTHER STATE.
CONSIDER THE MOST SEVERE REGULATION AS BINDING IN ALL STATES
UNLESS YOU ARE AN ATTORNEY LICENSED IN ALL STATES (AND CARRY
MALPRACTICE INSURANCE…
―Pretext interview‖ is widely considered as an ―interview whereby a person, in an attempt to
obtain information about a natural person, performs one or more of the following acts:
Pretends to be someone he or she is not.
Pretends to represent a person he or she is not in fact representing,
Misrepresents the true purpose of the interview.
Refuses to identify him or her upon request.
The first three of the above ―acts‖ are typical and common in a trust mill so any agent or in-
surance company that uses or authorizes the use of these practices, will be sanctioned under the
Insurance Information and Privacy Protection Act.
California, for instance, takes this regulation very seriously, as do other states. In California,
the Commissioner has requested that all agents and insurers review their marketing programs to
determine if they are involved with such an operation, with particular attention to any program
for annuity sales in which the insurance agent or insurer states or infers that they have particu-
lar expertise in the areas of law, finance or financial planning. The Commissioner instructs that
such programs should be corrected immediately and remedial action taken, including allowing
purchasers that were so unlawfully solicited, to rescind their contracts.
MISLEADING MATERIALS
Misleading‖ materials are specified advertisements that insinuate that the materials are from
or associated or affiliated with a governmental agency or nonprofit or charitable organization or
a senior organization. Most states require that no advertisement can infer or imply that the party
can lose a right or privilege or public benefits if they do not respond to the advertisement. To
help enforce these regulations, all advertisements by agents or producers, etc., must have the ap-
proval of the insurer, and agent's contract almost always require that the agent receive prior ap-
proval for all advertisements.
There are certain prohibitions in the state insurance code that apply to any advertising di-
rected at the age 65 and older market. As a general rule, pursuant to these prohibitions, an adver-
tiser may not engage in any of the following in its advertising:
1. An insurer may not use a name that is misleading or deceptive with respect to the status,
character or capacity of the person or concerning the true purpose of the advertisement;
2. An advertisement must not use words, letters, initials, symbols, or other devices that are
so similar to those used by governmental agencies, nonprofit or charitable institutions,
senior organizations, or other insurers that they could have the tendency to mislead;
17
3. An advertisement must not use the name of a state or political subdivision (city, county,
etc.) in the name of a policy or in its description;
4. An advertisement must not use any slogan, name, symbol, service mark or other device in
any way that implies that the insurer, its products or its agents who may call upon the
consumer in response to the advertisement are connected with a government agency, such
as Social Security;
5. An advertisement may not imply that the reader will lose any rights, privileges, or bene-
fits, etc. under the law by failing to respond to the advertisement.
6. In addition, as described earlier, an advertisement used by an agent must have been ap-
proved by the insurance company. Also, in case of a Seminar, etc, ―and insurance pres-
entation‖ must follow the terms of seminars,
In addition to the above requirements, agents and insurers may not
use an address for the purpose of misleading or deceiving others as to the true identi-
ty, location or licensing status of the insurance company or its agents;
use language in the name of the insurance policy or certificate that is to similar to the
name of a government agency or program that it could be construed as confusing or
misleading a prospective purchaser; and
solicit a particular class through the use of advertising that states or implies that their
occupational or other status entitles them to a reduction in premium, if the policies are
actually being sold on an individual basis at no premium discount.
USING ANNUITIES CORRECTLY AND ETHICALLY
With all of the negativism in respect to annuities, it might seem that annuities are "bad
news," even for the most ethical and conscientious agent. Such is not the case, particularly in
today's market. It is easy to scoff at and ignore the line "You can't outlive your income with an-
nuities." However, it is just as much a positive today as was decades earlier, however, it is more
attractive to those just ready to retired or who have retired than it has been in the past.
Recently, there have been articles about the "resurrection" of the annuity in financial articles
in the press, and importantly, these articles are the kind that are read by many people who have
the funds to purchase annuities in anticipation of retirement. One wells-known and well-versed
financial "guru to the masses" (as he has sometimes been called) very recently used himself as a
case-in-point.
He admitted that he has been married for 35 years but is not in his 60s and semi-retired, and
now what is important to he and his wife financially is not really how much they have saved, but
how much reliable income they can receive for life.
Typical of persons of that age bracket, at this time they have 3 sources of lifetime income: a
pension, (projected) Social Security benefits and a guaranteed minimum annuity withdrawal
from a Variable Annuity. They also, over the next ten years, will get interest and principal back
from maturing fix-income investments.
Many agents would consider him as a poor prospect as he has everything all lined up for his
retirement. Not quite.
18
He and his wife are looking for something to guard against inflation in the form of an imme-
diate income annuity that would pay them a monthly income rising 3 percent a year for life.
While guarding against inflation at the present time seems like unnecessary speculation, for those
who are in their 60s, they well remember when inflation was high and concern for the future was
even higher.
This writer indicated that he did not care much for income annuities—which was obvious
from some of his articles in the past, in some cases strongly recommending another savings ve-
hicle, which he accurately described in this article as "insurance products that turn our lump
premium into a lifetime income stream." Well put.
The "old" income annuity "ain't what it used to be." They now have some attractive features,
including the ability to adjust income payments based on need, payments that rise each year to
counteract inflation, some access to principal and wider choices for beneficiary benefits. He also
stated what insurance companies have been saying for some time, they have lowered markups,
which increases the income that the consumer receives.
What makes these plans so interesting today is the fact that people are living longer, tradi-
tional pension plans are disappearing left and right, and the Baby Boom generation are con-
cerned about whether they will actually get Social Security when they retire.
A recent study by University of Pennsylvania's Wharton Financial Institutions Center in a
study co-sponsored by New York Life makes a strong argument for annuitizing a considerable
share of the individual's retirement savings.
A Wharton Professor and an Associate Professor at Brigham Young University, recommends
that you "should begin by annuitizing enough of your assets so you can provide for 100 percent
of your minimum level of retirement income."
Then, they suggest that you "annuitize a significant portion," from 40 percent to 80 percent,
of anything left, but they also recommend that there should be enough liquid reserves for emer-
gencies or special wants or needs. They maintain that retirees who do not annuitize and instead
tap a diversified mutual fund portfolio to meet expenses "are subject to greater risk, often higher
expenses, and returns that are unlikely to keep pace with annuity returns, especially when risk is
taken into account."
Nothing in life is cast in stone and things change. Investments may do poorly, or the person
may "life too long" (remember that?), which is why many financial planners recommend with-
drawing no more than 4 percent of the person's savings the first year of retirement (in other
words, $4,000 for every $100,000), increasing these withdrawals by 3 percent each year. This,
obviously, takes care of inflation.
Several income annuities from top-rated companies for a $100,000 premium would pay a 65
year-old couple at least $4,800 the first year, and then increase payments by 3% per year until
both spouses pass on. If both die before getting back the $100,000, a beneficiary will get the
rest.
One of these articles recently explained how insurance can do this: ―Income annuities can
guarantee this higher income because of the pooling of risk—premiums from people who die
early subsidize those who live longer"—just in case that was a big mystery…
19
In addition, beside providing lifetime income for basic needs, the income annuity
allows the annuity holder to invest the rest of his savings more aggressively, potentially re-
sulting in more money to both spend and to pass on to others.
The Wharton professor was reported to have said, "By annuitizing enough money to handle
your needs, you can bequeath the rest, either now or later. If the guaranteed income covers all
your lifetime needs, you may be able to donate or give money away now, while you live.
STUDY QUESTIONS
1. An agent should not target the elderly for investment products and represent yourself to be a
financial advisor
A. unless you are fully qualified as a financial advisor and acquainted with regulations.
B. unless you have a QFA (Qualified Financial Advisor) designation.
C. without having an investment attorney in your employ.
D. unless you are a General Agent with a large mutual life insurance company.
2. Deferred annuities should not be sold
A. in California because regulations are too strict.
B. unless the annuitant needs funds fairly soon.
C. to persons who may an immediate need for cash.
D. except as a rider to a life insurance policy.
3. To stay out of trouble,
A. never sell annuities to those who are looking for a retirement plan.
B. show illustrations to prospects that show very fast growth of the cash value/investment.
C. provide competent advice which is in the best interests of the client.
D. never obtain an insurance license in more than one state.
4. When advertising an investment product,
A. it is best not to show any growth statistics as they then become engraved in stone.
B. make sure that the name of the agency/investment firm is misspelled.
C. advertising regulations can be ignored as they do not apply to insurance.
D. always show very aggressive growth of investments.
5. An ethical dilemma
A. can be arrived at by concentrating only on one alternative.
B. is not possible with investment products.
C. is beyond the capacity of most humans.
D. must have two or more solutions.
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6. When using an illustration in a presentation, there should be (mandatory in California) a no-
tice that
A. commissions are paid on the sale, and outlining the exact commissions.
B. this is only an illustration and is not intended to predict actual performance.
C. this is only an illustration, but all statistics are extremely realistic and can be expected.
D. all items not marked as guaranteed, are guaranteed anyway by the insurance company.
7. A marketing scheme used to sell annuities to senior citizens that hides the actual business of
the sales representative and hides the purpose of the solicitation is called
A. a pretext sale.
B. a living trust mill.
C. a seminar on real estate investing.
D. a ponzi scheme.
8. An interview whereby a person, in an attempt to obtain information about a natural person,
pretends to be someone he or she is not or is in fact representing, is called
A. a pretext interview.
B. a pretest interview.
C. golly-lagging.
D. fraud.
9. An advertisement, in nearly every case, but particularly in California,
A. must never run two days consecutively.
B. must state the price of the ad in the ad itself.
C. cannot be taken or paid for by an insurance entity.
D. must have prior approval by the insurance company.
10. An insurance agency does not want its location known to the general public as they do not
want insureds arriving at their doorstep, so they use a drop-box address in their newspaper
advertising.
A. This is allowed as long as it is an actual address.
B. They are also required to list their office hours.
C. This is not allowed as it does not list the true address and the drop-box address is
misleading.
D. This just lends credence to the idea that an agent must go to an insured, not vice versa.
ANSWERS TO STUDY QUESTIONS
1A 2C 3C 4A 5D 6B 7B 8A 9D 10C
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CHAPTER TWO – ETHICS
In everyday life, it is impractical to ask for a person to research the law before any action is
taken. Indeed, most people are honest and instinctively they know right from wrong. One stays
out of trouble by making sure that his actions are not "wrong."
Ethics do not concern themselves with the distinctions as to what is right and what is wrong
legally as these distinctions are governed by various laws, regulations, statutes, ordinances, etc.
Ethics, on the other hand, is much more subjective in making the distinctions between what is
good and bad.
Legal duties are precisely described so that the average man can conduct his affairs with ad-
vance knowledge about whether a particular act is legal or a violation of the law. Courts have
universally held that laws are unconstitutional if they are so vague that the common man cannot
interpret the meaning of the law.
On the other hand, ethical distinctions are not so cut-and-dried and each person has his own
ideas of what is right and what is wrong, such ideas differ by person, region, education, back-
ground, and a host of other causes. Some people do not feel that dog-fighting is unethical (forget
illegal) or is "wrong," but these beliefs have cost millions to those who think that it is nothing but
a sport. Yet a volunteer, who assisted in rescuing fighting dogs from a kennel, became violently
ill when she saw the remains of dogs that had been executed because they were not "fighters."
All civilizations have a common ethical sense about what is right and what is wrong, so we
have been told throughout the ages. Makes one wonder what the philosophers would have
thought if they had seen the carnage performed by young men and women strapping bombs to
themselves and blowing up hundreds of innocents. Still, core virtues, such as honesty, fidelity,
loyalty, integrity, and fairness are common among all members of the culture. From that point
on is where it gets rather fuzzy around the edges.
Core virtues are often, unfortunately, accompanied by "qualifying" or "explanatory" anti-
virtues, if you will, such as telling a "white lie," imagining "victimless" crimes, casual promises,
and the most evil of them all in the business of insurance: caveat emptor."
There is no such thing as "caveat emptor" in the insurance industry!
If anything, insurance should have the caveat venditor rule. These "anti-virtues" are easily
made and such promises are easily broken. They are also all bad for your ethical health.
Everyone has experienced discussions that went from a simple disagreement into an argu-
ment where each party claimed to be in the right. In order for such an argument to occur, both of
the parties must believe some common ethical code which each one feels is applicable to the be-
havior of both parties. What is happening is that each party is saying that the other's behavior
did not conform to what both believe is the accepted standard of behavior. Both parties agree on
the basic ethical principle, but they disagree as to how it is to be applied. So they argue as each
22
is trying to interpret each other's behavior in light of their own bias about what is acceptable out
on the fuzzy edges.
Actual example: A new church was presented with an American Flag by the Cub Scout
troop that had sponsored the troop. Two men of good faith became involved in the argument as
to where the flag should be located in the sanctuary. One man, a retired naval officer, insisted
that it should be on the stage near the podium (alter) as that is what is specified in the US Code
for chapels and it should, therefore, be to the right of the speaker. The other man disagreed as
higher officials from the church had decided that each church should have the flag to the right of
the congregation if it was standing on the floor and not on the same level as the alter—which for
some reasons was perhaps more practical. Who was right? Did it matter? It did to them, as two
of the members left the church although few even cared, just as long as there was a flag.
These arguments are complicated by the fact that we have a tendency to judge our own ethi-
cal behavior by our intentions, while we judge others by their acts. If we judged our own acts by
the standards that we have set for others, we would all discover that our ethical behavior is not
what it should be. Actually, none of us are quite as good as we think we are.
Conversely, if we judged the ethics of others using the same criteria as we used to judge our-
selves, we would give them the benefit of the doubt, and then there would be much fewer allega-
tions of dishonesty. Not many people can be as bad as we think they can be, but none of us are
as good as we can be. That is one reason that people are going back to church.
Okay, so that sounds warm and fuzzy, but where it gets heated up is when we try to justify
some act that is outside of the "fuzzy" area. Why do we do this—do something that we know is
not "right"—even though the ethics are clear? It is, simply put, because
People are often tempted to get something that they believe to be worth more
than the value that they place on remaining correctly and unquestionably ethical.
The REAL test of ethics arises when one is willing to do the right thing even if it is not in his
self-interest to do so. This happened to a friend: He has suffered from the loss of feelings in his
feet and ankles (peripheral neuropathy) and he had to give up his love of fishing and sell his boat
and expected never to go out again as he is a lousy swimmer and balance is a definite problem.
A mutual friend belonged to a boat club and offered to take him and some friends fishing out in
the Gulf in a nice, modern boat, and all he had to do was fish. The only problem was that the
boat was only available on a Thursday and he had volunteered to work with a youth group at the
church on Thursday and there was no one else to take the job. Sometimes it hurts to do the right
thing, sometimes it hurts badly.
It should be pointed out that it is not always in our own best interests to be ethical as being
ethical can come with a very high price tag. There are times when acting correctly and honoring
a commitment and while it is ethical, a sale, a job, a promotion can be lost—even a friend can be
lost.
To stay out of trouble, one must be ethical. Period. Living an ethical life requires a moral
commitment that many are not willing to give, particularly to sales goals and other such
"achievements." If one has the choice of being ethical or achieving any other goal, one must be
willing to forsake that other goal.
A speaker, Michael Josephson, at a CLU National Conference once put it:
23
If you are not willing to forsake other victories in order to remain ethical,
then you have already decided that you will do anything to win. To be ethical, you have to
be willing to lose.
ETHICS AND THE LAW
The members of the American Society are bound by a formal Code of Ethics, which is based
upon the pledge taken by all those with the professional designations of CLU and ChFC:
"In all my professional relationships, I pledge myself to the following rule of ethical conduct:
I shall, in the light of all conditions surrounding those I serve, which I shall make every con-
scientious effort to ascertain and understand, render that service which, in the same circums-
tances, I would apply to myself."
This Code contains two ethical imperatives that mandate that a member must provide compe-
tent advice which is in the best interest of the client and that a member shall act in a manner that
will enhance the public regard for the professional designations held by members.
Laws are a necessary function of civilization as they exist to set a minimum level of behavior.
Actions that do not conform to that minimum level will result in fines and penalties. Our legal
system creates an imaginary line, which separates, acceptable from unacceptable behavior. The
behavior that crosses that line is considered as outlawed behavior and is unacceptable.
Laws do not concern themselves with one's distance from that line—both shoplifting and
murder are outlawed. The magnitude of the crime is relevant to the victim and to the punish-
ment, but not to the fact that shoplifting and murder are illegal activities. Once the line has been
crossed, then the person is an outlaw. It has been said that in law, there is no distinction between
a said and a sinner, if neither one has violated any temporal laws. There are no degrees of legal
behavior—either a person is acting legally or he is not.
Ethical codes start with the assumption that all of one's actions are acceptable as all illegal
activity is unethical by definition. If one believes and accepts the premise that all ethical beha-
vior is contained within legal behavior, then there must be some legal behavior which is unethi-
cal. Otherwise, there would be no distinction between law and ethics and we can all forget about
taking ethics courses as all we would have to do is study law.
Of course, there is a distinction. Ethical codes elevate the behavior of men and women above
the level of those who just obey the law—the law may require a person to not tell a lie, but it
may permit him to give less than a complete answer. Giving less than a complete answer may be
legal but it would be unethical.
Example: "I never had sex with that woman" comes to mind immediately, but for practical
purposes, you try to sell a Universal Life Insurance policy to your client (how many prospects
actually understand Universal Life – really?). When asked if it was a good policy, you reply that
"That is the same kind of policy I have on my own life." While that may be true, you may, for
whatever reason, be planning on replacing your policy. You have not lied so legally you are OK.
Ethically, not so good. The legal response is, in effect, unethical.
24
If it is ethical to disclose the truth always, then ethics may thereby require the disclosure of
unsought information, which, if revealed, could kill a sale or could just be adverse to the interests
of the seller. Not hard to figure this. Remember, earlier, "The Code of Ethics provides that a
member shall provide advice and service which are in the best interest of the client.‖
To put it even more simply, the marketer has an ethical obligation to use his professional ex-
pertise for the benefit of the client, and further, he must avoid taking advantage of that know-
ledge to the detriment of the client. It, therefore, follows that when a conflict arises between the
interests of the client and the marketer, the interests of the client must be paramount. Period.
End of discussion.
Ethics are enforced by professional organizations as a violation of the Code of Ethics of the
organization could cause a member to be sanctioned, reprimanded, and in some cases, expelled
from the organization. In many such cases, a legal violation would automatically include the
ethical breach. A minor traffic offense would not necessarily have anything to do with an ethical
violation, although some crimes or civil acts are arm-in-arm with ethical behavior.
Although, it is entirely possible that a person has acted legally and is still in violation of the
Code of his organization. Therefore, for such Codes to be most effective, the gap between ac-
ceptable behavior in the eyes of the law and ethical behavior is maintained and encouraged.
JUST FOR FUN
You are driving down the road in your car on a wild, stormy night, when you
pass by a bus stop and you see three people waiting for the bus:
1. An old lady who looks as if she is about to die.
2. An old friend who once saved your life.
3. The perfect partner you have been dreaming about.
Which one would you choose to offer a ride to, knowing that there could only be
one passenger in your car?
Think before you continue reading.
+++++++++++++++++++++++++++++++++++
This is a moral/ethical dilemma that was once actually used as part of a job application. You
could pick up the old lady because she is injured and will die, and thus you should save her
first. Or you could take the old friend because he once saved your life, and this would be the
perfect chance to pay him back. However, you may never be able to find your perfect mate
again.
The candidate who was hired (out of 200 applicants) had no trouble coming up with his an-
swer. He simply answered: "I would give the car keys to my old friend and let him take the
lady to the hospital. I would stay behind and wait for the bus with the partner of my
dreams."
Sometimes we gain more if we are able to give up our stubborn thought limitations. Never
forget to "Think outside of the box."
25
ETHICAL THEORY
Ethics actually can be a code of personal ethics, used in everyday life, and is more philosoph-
ical (and religious to many). These give the person great satisfaction, and affects both the per-
sonal life and professional life. Practically, though, ethics helps one to avoid controversy and
misunderstandings and become more efficient in their occupation. While most of us see a dis-
tinction between knowing that it is wrong to steal a candy bar, it becomes a problem where a
multi-form application for insurance is missing one signature and the applicant needs the cover-
age as they are leaving the country tomorrow–is it ethical to "window pane" (forge) the signa-
ture?
Very simply put, ethics can be considered as a set of instructions on how to deal on a daily
basis with a group and with a community, and which revolves around social behavior that favors
the group over the individual. Because this is so, communities throughout the years used ethics
as a base for common law which has evolved into our civil and criminal laws.
If everyone could "ponder" different choices of actions in order to determine the proper di-
rection, it would be a better, but slower, world. Unfortunately, in today's fast-paced environ-
ment, it is difficult to have the time to thoroughly "think through the problem." This also leads
to a person focusing on practical and expedient solutions whereas their main consideration
should be the ethical approach.
DEFINITION OF ETHICS
Ethics, according to textbooks, is "a branch of philosophy that deals with the values of hu-
man life in a coherent, systematic and scientific manner." Webster says:‖ the discipline dealing
with what is good and bad and with moral duty and obligation." Legally, Black's Law Dictio-
nary says: "(1) Of or relating to moral obligations that one person owes another. (2) In confor-
mity with moral norms or standards of professional conduct."
These definitions doesn't really give much information to the student, but if it seems confus-
ing, you can take solace in the fact that even philosophers disagree as to what is ethically correct.
Kant, a German philosopher stated that what is right is based on pure reason. But another philo-
sopher, Jeremy Bentham, believed that right is that which will produce the greatest good. Reli-
gious philosophers, St. Thomas Aquinas comes to mind, said that right is determined by the will
of God and wrong is anything that is contrary to God. Several texts believe that Albert
Schweitzer said it best: "Ethics is the name we give to our concern for good behavior. We feel
an obligation to consider not only our own personal well being, but also that of others and of
human society as a whole."
Now, there should be felt a common thread among all of these definitions. Those with Chris-
tian religious training—even just a little—can remember from the Gospels of Matthew and Luke,
"Do unto others what you would have them do to you." It may be surprising to learn that this
rule is also fundamental to Confucius, Aristotle, and to Buddha. This is often stated as "love thy
neighbor as thyself."
This rule is often presented as "treat others as you want to be treated." If a little thought is
given to this, it will be realized that this rule promotes consistency and eliminates double stan-
dards. It, in turn, creates two questions: Do you treat others differently than how you treat your-
self? If such is the case, is more expected from others and less from yourself?
26
Ethics, obviously, is not a set of hard and fast scientific rules, but they deal with attitudes,
ideas and beliefs. Ethics have sometimes been defined as a set of instructions for a way of life
that allows a person to live in harmony with others.
Ethics favors the group over the individual .
ETHICS vs. SUCCESS
Today's society has a tendency to often reward unethical actions as they are ignored in the
search for "success"—usually defined as how much money one is making. In case it is not ap-
parent, many people are impressed with how much money a person has, and not in the way that
such money was made.
Example: For football fans, the names may come easily. One NFL player has (had) a multi-
million dollar contract, plus a bunch of money from endorsements. His hobby (it is discovered)
involves dog-fighting and he has financed a "fighting dog ranch." Another NFL player on the
same team has a good contract, but is not one of the highest paid. He has overcome the (huge)
problem of being undersized and is praised as an honest, hardworking team-oriented player who
is well known for helping poor and impoverished families get into their own homes. Which is
the most successful?
Financial gain is a method used by the insurance industry to motivate employees. No real
problems there, as long as employees are not motivated entirely by finances. "Top Producer of
the Month," "Lifetime MDRT Member," etc. are awards, but in some fashion they spotlight fi-
nancial achievement but often ignoring professionalism and public service. The problem is that
it is not always acknowledging success through financial gain and ignoring service to others, but
it is extremely difficult to set up guidelines to honor those who serve their fellowman best.
If an insurance agent does not think that their relationship with the insurance company that
they represent is mostly or entirely based upon what they can do for the company, then what oth-
er means does an insurance company, usually located miles away (often in another state), have to
evaluate the services of the agent, whether he be employee or private contractor?
One of the problems in this relationship is, of course, that the company contains many indi-
viduals, each of whom differ from the others in respect to how they deal with each other. The
Agency Department judges by production, the Underwriting Department judges by quality of the
business, the Actuarial Department has very little relationship one way or the other, the Claims
Department are concerned with how a policy was presented and sold, etc.
Having worked closely with Underwriting Departments at one time, it soon became obvious
that many underwriters closely judged agents by their ethics. On several occasions, agents have
their own list of those agents that they can "trust" and those that they cannot. For instance, an
agent who notifies the company that although the application being submitted has been com-
pleted correctly, the agent has some problems with the character of the applicant—ranging from
obvious family abuse, to obviously living way beyond their means, to obvious physical problems
(wheelchair in the corner, for instance), etc. The agent is risking his commission (read livelih-
ood) but he is doing what he feels is right. These underwriters often have a list or a file of those
agents they consider as ethical in their dealing with the insurer, and if there are situations where
27
the agent needs a favor (such as where the applicant is overweight by the charts but is a body-
builder in excellent condition—happens often) the underwriter will work with him, or the un-
derwriter will take extra effort to make sure that his cases are processed quickly. Ethics at work.
Okay, some purist may argue that the underwriter is not ethical by giving applications from one
agent precedence over others… Sometimes realism runs smack into ethics.
Still, keep in mind,
Ethics is personal in nature and does not demand that one trust other impli-
citly—one has little control over the conduct of others, only over their own conduct.
ETHICS AND THE LAW
Sometimes there exists a conflict between ethics and the law as ethics deals with the way that
things should be, but which may not be entirely practical in our society; such conflict creates
confusion among many people in trying to determine the difference between ethics and the law.
These are two separate concepts as ethics is determining what is right for "rights" sake, while the
law is a set of minimum standards that society needs in order to function in a civilized manner.
Still, as stated earlier, the law is based upon ethics, and while many ethical standards of con-
duct have become law (codified), some have not for whatever reason. It is not illegal to sell a
person more life insurance than they need or can afford, but it is unethical.
Under the law, ethical conduct is defined as that which a reasonable person is expected to do
under the circumstances. The actions of a reasonable person are an important part of civil law.
Law takes ethics a step further and defines what is illegal, what is improper conduct, and the pe-
nalties for such conduct.
These distinctions can lead to problems sometimes. If a person commits an act (or is con-
templating an action) and they can then say that their action is not illegal, ergo, it must also be
ethical. False advertising, questionable sales tactics, gifts-to-obtain-business are all unethical but
may not be illegal. And sometimes, what is unethical today can become illegal tomorrow (think
congressional "perks" [unethical] such as family trips on constituent's private planes—all at once
they are now considered as "bribes" [illegal])
Unethical selling of used automobiles that have been wrecked, for years was just considered
as unethical. Now "lemon laws" and other laws have stopped a lot of this misrepresentation.
There is a hazard here, however, inasmuch as some will rely on illegalities only as that is the
easy way to solve a dilemma, therefore keeping the individual out of trouble, but they have a
hard time looking at themselves in the mirror the next morning.
RULE: DO NOT DO ANYTHING THAT WILL NOT ALLOW YOU TO BE
SATISFIED WITH YOUR REFLECTION IN THE MIRROR IN THE MORNING!
You might just be getting the idea that in order to stay out of trouble, one must not only not
commit illegal acts, but they must also not commit unethical acts. Have you ever heard "That act
will come home to bite him in the (rear)—you just wait and see?" It's true usually.
28
A number of bank and store robberies have been "thwarted" because the robber "got cold
feet" and for got the whole thing and just ran away. Was this because of the fear of going to jail?
Those that were caught admitted that usually they were not afraid of jail, but they just knew that
"it was not the right thing to do." Ethics at work.
One could (rightfully) ask at this point, ―How does this apply to insurance and insurance
sales?‖ The best way to answer such an inquiry might be to recall actual instances of unethical
behavior. Some of these situations would now not only be unethical, but also illegal. One thing
to keep in mind is:
Repeated unethical activity will, in most cases, eventually be made illegal.
For those in the Health Insurance industry, it appears that most publicized unethical actions
over the past few years have occurred in this particular line of insurance. There are several rea-
sons for this, with the result that this branch of insurance seems to have suffered more regula-
tions and more ―housecleaning‖ probably more than any other area of insurance.
Any Health Insurance agent who has been active very long, can still remember situations
where it was discovered that a policyholder has multiple coverages on the same risk because a
―slick‖ agent convinced them that they needed the coverage (that could never be used) for a va-
riety of reasons. The elderly are obviously the most gullible, and there have been (are?) agencies
that target elderly widows as many (if not most) were in an unfamiliar position of having to
make financial decisions formerly handled by their late husbands. Many agents have seen ―port-
folios‖ of duplicate (or even triplicate) coverages.
As discussed earlier, ―financial planners,‖ many of them former ―agents‖ are under scrutiny
in the modern market. A large problem in ethics arises where, for instance, a ―financial planner‖
who is also an insurance agent, is made privy to the financial records of a client, and who then
passes this information on to a stockbroker or mutual funds salesman, sometimes for a ―fee‖ and
sometimes for ―goodwill.‖ This raises many questions— such as should the agent disclose his
connection to the broker to his client and would that make it OK? Or is it just the right thing to
do if it is apparent the client would benefit more by investing in a mutual fund or whatever?
WARNING: For agents who normally do not market health insurance but are in-
volved in financial and/or estate planning, it is strongly suggested that when working with
persons who are covered by Medicare (the vast majority over age 65), do not touch, discuss,
recommend, or in any other way become associated with or indicate any interest or exper-
tise in, Medicare Supplemental insurance.
These policies are basically an "easy sell" because the federal government has required that
there only be 10 such plans and every insurer who sells these plans must offer exactly the same
plans. There are a few variations, particularly if an HMO is involved, and it may look like an
easy way to pick up a few dollars if a company that you are representing offers these plans. But,
unless you are very familiar with Medicare and Medicare plans and are well trained in those
plans, do not attempt to sell the Medicare Supplement policies, or even recommend companies
that do offer such plans.
"Financial advisors" are often asked about Medicare Supplemental policies, and the smart
ones deny any knowledge. This is smart because (1) change is really not welcome to the typical
29
senior citizen, (2) usually the person has had his Supplement for some time and his premiums are
usually based on his age when he first took out the policy—if he changes, his now attained age
would determine his premiums and in most cases (he is older now, and generally that would
mean his premiums went up), that would make a new plan less affordable, and (3) the commis-
sions are so small that it is not worth the effort.
TEMPORARY INSURANCE AS SUBSTITUTE
In respect to health insurance, there is an interesting situation familiar to many health agents,
wherein a client comes to them with the problem of unaffordable premiums with their present
carrier because of age, and they are nearing the magical age of 65 when they will be eligible for
Medicare. Many agents will suggest a ―Temporary‖ policy with higher deductibles and which
are usually issued for only one year and have limited health questions, but have a much lower
premium. One of the primary reasons for the low premium is that they do not cover any preex-
isting conditions under any circumstances. For relatively health older persons, this is acceptable
and in some cases, commendable from the viewpoint of the client.
An ethical problem can arise, however, in some situations, if for instance, the client has 3
years (or so) before qualifying for Medicare. Some agents simply find another (a good Health
agent will usually have 2 or 3 applications in their briefcase) and rewrite the policy with another
company. The problem is that there is NO coverage for preexisting conditions, and sometimes
the agent ―forgets‖ to tell the client that any illness that occurs while covered by a Temporary
policy, will not be covered under the new Temporary policy. So the client could find themselves
without coverage for a couple of years if they should become ill when covered by the first Tem-
porary policy. An ethical agent, as most are, will certainly make sure that the client fully under-
stands the hazard involved with the Temporary policies.
WHY A DISCUSSION OF “ETHICS”?
It simply is not possible to discuss ways to "stay out of trouble" with insurance companies,
clients and regulatory bodies without a discussion of Ethics. Insurance Departments usually re-
quire some basic courses in Ethics for Continuing Education, but these courses generally address
only Ethics. Some may resent having to study about ―Ethics‖ because they consider themselves
tremendously ethical, and besides - doesn‘t everyone know the difference between right and
wrong and everyone knows that if they cheat their clients, they are unethical?
They may have a point inasmuch as in many cases, one can determine whether a particular
action is ethical or not, just by using good judgment.
The greatest tool for ethical conduct is just good sense.
But, if every situation that arises were clear-cut, then this book would not be necessary (and
the world would be a better place…). Often given as an example of ―everybody knows,‖ ―eve-
rybody knows‖ that if a life insurance agent talks a client into cashing out an existing policy and
replacing it with another like or similar policy, but which pays a new first-year commission, that
is wrong, a real no-no, end of discussion.
30
OK. But, how can you explain an agent that defrauds his clients in this manner? This brings
up the point of whether there are bad agents who sometimes do good things and/or good agents
who sometimes do bad things. The point (yes there is one) is that
for some agents, what is right and what is wrong is not as apparent to them as it is
to others.
EXAMPLE OF BREACHES OF ETHICS - EQUITY FUNDING
The story of Equity Funding is a true and actual story of company ethics gone haywire and
insurance executives completely ignoring ethical behavior. One of the interesting sidelights of
Equity Funding was that the agency force apparently had no actual knowledge of misdeeds, but
there is little doubt that some of their large general agents had an inkling of something going on
as they had a hard time believing that the company was writing as much business as it was claim-
ing. When they asked about it at the home office, many of them were never completely satisfied
with the answers.
RULE: IF THE INSURANCE COMPANY THAT IS REPRESENTED IS WRITING
MORE OR LESS INSURANCE THAN OTHER SIMILAR COMPANIES, FIND OUT
WHY.
On April 2, the Wall Street Journal headlined ―A Scandal Unfolds – Some Assets Missing,
Insurance Called Bogus at Equity Funding Life. Allegedly Phony Policies Sold to Reinsurers for
Cash – Firm Declines to Comment.‖
(Quoting from Wall Street Journal) ―From Beverly Hills, California, comes the story of
the one of the biggest scandals in the history of the insurance industry, breaking around Equi-
ty Funding Life Insurance Corp. of America, a financial services concern with a ―go-go‖
growth record in insurance sales. This scandal centered on the life subsidiary, Equity Fund-
ing Life Insurance Co. This company had four subsidiaries, and they reported total life in-
surance inforce of $6.5 billion at the end of 1972‖ (a substantial company in those days) and
Equity Funding Life accounted for about half of that.‖
―An unknown ‗but sizeable‘ hunk of this insurance did not exist, apparently bogus busi-
ness put on the books and then ‗sold‘ to reinsurers for cash. Known in the company as the
‗y‘ business, it was conceived and operated by several managers and executives of the sub-
sidiary and parent company and treated as a big joke.‖
This story contains many ethical questions, particularly accounting ethics, but it involved
more than just ―accountants.‖ It also involved company underwriters, policy issue, actuaries, and
policyholder service personnel that were aware of what was going on to some extent or other.
Agents, for the most part, were kept in the dark. However, there undoubtedly were large General
Agents representing Equity Funding that claimed no knowledge of wrongdoing all the way to the
bank. While they did not participate directly in the funds illegally obtained through fraud from
31
the reinsurers, they had the most lavish agent conventions in luxurious hotels and rewarded their
agents better than similar companies.
The point is that it had to be obvious to those participating in this gigantic fraud, they HAD
to know that they were not only operating in total violation of any ethical code created by man,
and of course, it was stealing so it was also illegal. What is interesting is that in interviews with
some of the persons involved, to most it was just a ―big game.‖ Actually, it was certainly more
than that because those involved in falsifying thousands of policies, were paid extremely well.
IGNORANCE IS BLISS?
―Ignorance‖ of ethics has universally been understood to start at early childhood. This is ob-
vious in those situations where the parents have been involved in unethical and/or illegal activi-
ties as the child soon learns to accept such action as the ―norm.‖ If they are exposed to such ac-
tivities, not only from family but also by others with whom they associate, they will soon devel-
op the attitude that ―it must be right because everyone does it.‖ Obviously, a child that grows up
in such an environment will not know what‘s right or what‘s wrong.
Bad ethics are often taught by example.
So how does that apply to an insurance agent? Consider the following situation:
John joins the Acme Insurance Agency after selling siding for several years. He is
trained by an experienced agent designated as a ―trainer‖ because he has the highest produc-
tion (not highest ethics), a rather typical situation. John is a good student, and one of the
things that he learns is that there always are several forms to be signed by the client. If he
turns in a form that is not signed, he does not get paid for it until he goes back and gets the
required signature.
One of his early sales was for a substantial policy and he was looking forward to his
commission check until he discovered that the applicant had not signed one form. Remem-
bering that the applicant was not a particularly pleasant individual and had been a rather hard
sell, plus the fact that the applicant had stated he was going on vacation for 3 weeks, brought
John close to tears. In admitting this to his ―trainer‖ who lent a sympathetic ear, the more
experienced agent offered to ―get the signature.‖ John could not believe it, but when the
agent came back to his desk in a couple of minutes with a signature that matched the other
signatures on the application, John was introduced to the practice of ―windowpane signa-
tures‖ - holding a signed form to the window, and then tracing the signature onto another
form at the proper place.
Assume that John knew that forging a signature was wrong (and illegal, to boot). What
has he learned? He has learned that it is OK to ―windowpane‖ a signature when necessary,
because that is not really ―forging.‖ Besides, if his trainer does it with all of his experience,
then it must be OK.
Unfortunately, this is how many agents learn their ―ethics.‖ Taking this one step further, as-
sume that John moves to another agency where he is put in charge of training of new agents. As-
sume further that John teaches ―windowpane signatures‖ to a new agent, and John is proud when
the new agent brags on how his trainer had saved a case for him. Further assume that the owner
32
of the new agency was highly ethical and besides, the agency owner knows he will lose his li-
cense if one of his agents is caught forging an application with his knowledge. The result would
be obvious – John would go back to selling siding and not fully understanding why he lost his
good job as a trainer.
Sales ethics are the hallmark of the marketing entity.
If a person’s early training taught that one could get away with wrongful acts
and make money; then the individual needs re-training and re-education as to what is right
and what is wrong, and WHY it is right or wrong.
OR GREED?
While some people act only out of ignorance when making ethical decisions, the ugly green
monster, greed prompts others. The demon that perches on everyone‘s shoulder is more active
with some than with others. Nearly everyone will admit to having done a ―wrong‖ at some time
or other (or else they are lying) and psychologists have discovered that people respond positively
to rewards but negatively to punishment – no startling discovery, even Adam in the Garden of
Eden knew that, or should have.
In business, and insurance is a business (yes, it is), companies will reward the high producers
with bonuses, gifts, commission increases, trips to exotic places, and whatever other rewards
seem to ring the bells of the producers. Productivity is rewarded, often regardless of how it was
achieved. It is no shock to discover that persistency of insurance is worse on business sold dur-
ing a company promotion, ―President‘s Club‖ qualification period, or some other such contest
period.
If only productivity is rewarded, any sales with any business suffer in quality
when increasing in quantity.
No one is perfect – even Mother Theresa admitted to imperfections and recently some of her
diary entries were discovered where she questioned some of her beliefs. Often quoted in these
types of discussions is the situation when Abraham Lincoln threw a man out of his office for at-
tempting to bribe him. When he was asked as to why he had thrown the man out, Lincoln rep-
lied that the man ―was getting too close to his price.‖ This simply points out that nearly every-
one has his price.
Since realistically we probably all have our ―price,‖ the smart person will
simply not put themselves in situations where they are tempted.
CHARACTER
We have all heard the word ―character‖ in referring to certain individuals. Some seem to
have it, and some don‘t. Actually, those who have overcome temptation tend to have developed
33
a stronger character as a result. So – what is character? The dictionary has about 50 lines (in
small print) of definition, but the most applicable would be: ―one of the attributes or features that
make up and distinguish the individual.‖ Therefore
the goal of an ethical individual is to develop a strong character.
Many scholars, authors, and others, consider virtue as the telling factor in a strong character.
Simply put, virtue is like a habit to do good things, such as ―honesty is a virtue.‖ Virtue is not
something that anyone is born with, but it must be developed. Children go through a phase when
they come up with some ―whoppers‖ and while this upsets many parents, it is a natural part of
growing up and it is the responsibility of the parents to teach honesty (a virtue) to the child.
On the flip side, people can develop habits of doing ―bad‖ things – this would then be called
a ―vice.‖ People usually don‘t state doing ―bad‖ things all at once - like virtue, it must be devel-
oped. Normally it is not taught by parents, but by others in the environment, associates, friends
and those to whom a child respects. This usually starts with something small, like a ―little white
lie‖ that gradually develops into falsehoods so rampant that people simply no longer believe
them. Unfortunately, it is easier to develop ―vice‖ than it is ―virtue,‖ as virtue demands conti-
nual attention and it must be exercised frequently. Since it is harder to be virtuous, virtue is
praised more by others.
People, nearly all people, at some time in their life face situations where they can easily suc-
cumb to temptation to do something that they know is wrong, even though they know that anoth-
er action would be right. Unfortunately, many people take the low road. The importance of eth-
ics training comes into play here, so that the person will do what is right and will be therefore,
working towards building a strong character.
QUANDARIES
When a ―What to do, what to do?‖ situation arise, it is called ―a quandary, dilemma, or just
―a gray area.‖ This situation comes into play when it is just not clear as to what is right and what
is wrong.
A quandary or dilemma occurs when in a certain situation, the person is not sure as
to what to do, as there are good reasons for the action and good reasons against it.
Recently, the CEO of the New York Stock Exchange decided to cash in his retirement funds
for estate planning purposes accumulated over the past 16 years. This totaled some $120 million
and caught the eye of the press, making the headlines for a couple of days. He maintains that it
has all been collected legally and under the provisions of his contract with the Stock Exchange,
and at this point, there is no evidence to the contrary. But it is obvious that with the hue and cry
of the self-appointed guardians of the press, his days are numbered. It may have been legal, but
was this ethical?
He evidently found himself in a quandary as to how to collect these funds, and one must sup-
pose that there were good reasons for taking it in one lump sum as he did, or to spread it out in
some fashion so that it could be more easily understood. Was it ethical for him to take it in one
lump sum, considering the fact that during his reign, the stock market (probably through no ac-
34
tual fault of his) had fallen drastically and many investors, including retirees, who had invested
in stock handled by the NYSE - lost their nest eggs. Was this right, or wrong, or just in a ―gray
area?‖
INSURANCE QUANDARIES
It is quite easy to find oneself in a quandary in the insurance business. Assume for instance,
that a client is an elderly widower, decides to disinherit his children because they are objecting to
his wanting to leave most of his money to a nursing home that had taken care of his late wife and
is now taking good care of him. You are a financial planner so you are familiar with his situation
and he respects your advice. But when asking for up-to-date financial information, you discover
that the person who has been making his investments is the son of the owner of the nursing
home, and he has informed your client that his investments have tripled in worth since he took
over – which is dubious, to say the least.
What should you do? Following the professional code of ethics, should you investigate this
further, or should you simply do as he asks, and change the beneficiaries of his estate (and poli-
cies) to reflect his desire to name the nursing home?
Or, should you perhaps contact his doctor to make sure that his mental condition is good
enough to make such an important decision? And even ―stickier,‖ understanding the need for
confidentiality, do you contact his children (assuming that you know them well as decent human
beings)?
ANOTHER DILEMMA – CONFIDENTIALITY OR PROTECT A CHILD
A good illustration of a dilemma is the situation where a financial planner was working with
a woman who had inherited some money and wanted to do some planning for retirement. Dur-
ing the initial conference, the lady provided detailed confidential financial information to the
planner as he requested. She and her late husband owned a large day care center where she still
worked. During the interview she stated that she had to pause for her "medication" as she was
terribly distraught over her husband's sudden death (auto accident) and she had relapsed into a
state of paranoia and manic depression.
After gathering her financial and personal information, the planner was going to give the
woman a quote and information on what he could help her with in regards to her financial future
as she wanted to make sure that everything was OK and wanted to run it by her lawyer. The next
day the planner had to take his daughter to dance practice and stopped by on the way to give the
draft of the financial plan to the woman. She happened to be outside when he pulled up and his
daughter saw the woman.
When the planner returned to his car, his daughter said, "That is Mrs. Manning, I didn't
know that you knew her." When asked who "Mrs. Manning" was, the daughter informed him
that she ran the daycare center where she went when she was not in school and her mom and dad
were at work, along with the children of several close friends.
Dilemma! All information obtained from a prospect is confidential information and the
planner could get into trouble if he passed this on to anyone else or if he made it public that the
lady was paranoid and delusional. On the other hand, he did not want his daughter to be around
this lady when he and his wife were at work. He could send his daughter elsewhere, but then
what should be tell his friends, if anything, about her mental condition. Does he owe the same
35
protection to his friends as he does to himself? Or does the confidentiality override any personal
concerns for the safety of his child and/or the safety of other children? What would YOU do?
TRYING TO RESOLVE DILEMMAS, QUANDARIES OR CONUNDRUMS
These decisions are not easy, and as the world of business become more complex, so do the
ethics decisions. But before a dilemma can be solved, there are certain steps to be taken before
one can start applying ethical theories or ethical principles.
COLLECT PERTINENT INFORMATION
Every effort must be made to collect all of the information possible that pertains to the ―di-
lemma.‖ In the situation previously discussed, it would be easier to make the proper and ethical
decision if it were known that the client is not incompetent. It may be surprising to learn that
Many quandaries are solved when all of the information is collected.
DISCOVER ALL OF THE PLAYERS
Before it can be determined as to what is fair, all of those involved in the
dilemma must be discovered.
Sometimes this is not easy and will require a lot of ―digging,‖ but as they say, ―You can‘t de-
termine the program until you know the players.‖ Sometimes there are hidden agendas discov-
ered when all participants are known. Also, sometimes there are those with ―shady‖ reputations
on one side of the question, which would raise red flags and which alone could determine the
proper ethical decision.
DETERMINE THE OPTIONS
Some ethics ―consultants‖ maintain that since a dilemma (or quandary) must have at least
two options, in order to determine the proper option, a third option is necessary. The reasoning
seems to be that if one has not spent enough time and thought to the problem without coming up
with at least a third option, then they simply haven‘t thought enough about the problem.
In any respect, practically speaking,
Before a dilemma can be solved, there MUST be another choice, other than just two.
There would not even be a dilemma if there were not two choices – a right choice and a
wrong choice – and the dilemma is trying to figure out which is correct. Sometimes the third
choice is an acceptable combination of the other two, sometimes it is completely different, but in
any case, it usually is not easy to discover.
ESTIMATE THE AFFECT OF THE OPTIONS
If the action under consideration is fair to all parties, benefits the client, and is consistent with
such actions in other situations, then there really is no reason not to choose that action. Con-
36
versely, if taking such action requires that a commitment is broken, it is harmful and unfair, then
that action would not be proper.
Of course, it is really not that easy in ―real life,‖ primarily because of the conflict that occurs
when an action is beneficial but it still not fair – hence the quandary/dilemma.
STUDY QUESTIONS
1. Two words that should not be used in the insurance industry are
A. sold out.
B. illegal notations.
C. caveat emptor.
D. caveat venditor.
2. People are often tempted to get something that they believe to be worth more than
A. the value they place on remaining correctly and unquestionably ethical.
B. they know they can get for it on E-Bay.
C. what it really is because people are basically stupid.
D. the hassle of doing what is right.
3. If you are not willing to forsake other victories in order to remain ethical, then you
A. must never lose.
B. have already decided that you will do anything to win.
C. will die a rich man.
D. rely too heavily on the legal aspects.
4. The Code of Ethics of the American Society (CLU and ChFC) mandates that the member
must
A. never find himself in a situation where he must provide competent advice.
B. have his professional designation engraved on his business card.
C. not air his dirty linen in public but shall so inform his insurance carrier.
D. provide competent advice which is in the best interest of the client.
5. Ethics can be considered as a set of instructions on how to deal on a daily basis with a group
and with a community and which revolves around social behavior
A. that is the antithesis of proper behavior.
B. that favors the group over the individual.
C. with those of like interests and station in life.
D. that is only legally correct.
6. Ethics
A. favors the group over the individual.
B. favors the individual over the group.
C. favors neither the group, nor the individual, nor the rich, nor the poor.
D. is extremely "me" centered.
7. Repeated unethical activity will
A. be absorbed by the community to where it will become ethical.
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B. in most cases, eventually be made illegal
C. soon be covered by the passing of time and be laughed at later in life.
D. soon become a religious fiat.
8. The greatest tool for ethical conduct is
A. repeated actions.
B. print.
C. formal education.
D. good sense.
9. Since, realistically, we probably all have our "price," the smart person will
A. avoid clichés like the plague.
B. keep his price reasonable according to the value of the object.
C. not put himself in situations where he may be tempted.
D. play games with ethics and operate on the fringe of ethical/unethical.
10. In order to solve a dilemma,
A. there must only be one choice.
B. there must be another choice, other than just two.
C. the dilemma must be studied in all detail, and when the easiest path unfolds, take it.
D. pass it on to another person who has no prior knowledge of the dilemma.
ANSWERS TO STUDY QUESTIONS
1C 2A 3B 4D 5B 6A 7B 8D 9C 10B
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CHAPTER THREE - ETHICAL THEORIES
The principles of fairness, consistency and beneficial to the proper parties, plus such things
as ―morality,‖ and other such items to consider, may be called ―ethical theories‖ that form the
basis for ethical rules. But as one would suspect, very rarely is there a clear-cut situation where
such rules can be applied with no hesitation and with knowledge that the ethical solution has
been reached – no ifs, ands or buts.
What if you promised your family to take them to Disney World this summer? However,
just a few days before the planned trip you are informed that your daughter, who has a learning
disability, must be tutored during the summer months in order for her to be admitted to the next
grade with all of her friends. This presents a dilemma as the tutoring will be expensive and you
are not sure that you can afford it and keep another promise to your son to buy him a new bicycle
so that he can go to and from Little League practice and games in the Fall. Also, if you took a
week to visit Disney World, your daughter would lose that much tutoring and the information
that she did not learn could be crucial to her final grade and for her moving to the new class.
This is called a ―real‖ dilemma as more than pure reasoning is involved, obviously there are
emotions involved too.
There are those who appeal to fairness and rights over the consequences, and
then there are those who appeal to consequences over fairness and rights.
No discussion of dilemmas would be complete without bringing up the decision that was
made by President Truman to use atomic bombs in Japan, and by doing so, ending World War II.
Those who agreed with his decision say that it was worth taking the estimated 80 or 90 thousand
Japanese lives in order to bring this bloody war to an end, and otherwise, in all probability, it
would have cost millions of lives if the country of Japan had been invaded. On the flip side,
there are those who (still) maintain that dropping the bombs was immoral and not just because of
the loss of innocent lives.
These dilemmas cry for solutions, and multitudes of such dilemmas arise every business day.
Solving these dilemmas is what gives us ―ethical theory‖ and which requires more study.
Simply put, an ethical theory lays the foundation for a principle, which in
turn constitutes the most important justification for pursuing or following a course of
action.
In determining whether an action is ethical – or not – depends upon ―who is asking?‖ to a
great extent. There are those who prescribe an action for ethical reasons as to whether it benefits
more people than it harms. Those who automatically look at every situation as whether or not it
is ―fair‖ regardless of the consequences, might look at a situation differently than one who al-
ways looks at every situation in the light of what benefit it would be to him (her).
39
A few words in respect to each of these groups of people who usually look at the same situa-
tion differently. Those that look for the benefit to themselves find that problems arise when what
is good for them can only be accomplished at the expense of another. This is the key for whether
such consideration is selfish, or just self-concern. Selfishness would indicate that the extreme of
ignoring how an action would affect others, is the most common example of unethical behavior.
In the insurance professions the code of ethics requires one to act in a way that will best serve the
public interest.
DETERMINING ACTION IN LIGHT OF THE CONSEQUENCES OF THE ACT
Another type of person will always determine an action in light of the consequences of the
act and they will then always compute the benefits and the harm of every action. Therefore,
An action may be justified if it brings more happiness than unhappiness for
more people.
This seems rather straightforward, but the problem is determining whether an action brings
out the maximum amount of good, or whether it is good to a maximum number of people. If it
brings out the good to a maximum number of people, then the problem becomes as to how these
―goods‖ are to be distributed. Next problem is: How does one decide as to what counts as
―good?‖
Sometime ―good‖ is defined as to what satisfies the desires of the individual the best – ac-
tually defining ―good‖ as pleasure and happiness. Happiness is considered by many as the ulti-
mate ―good.‖ This discussion can (and does) fill page after page in text books, but it is presented
just as an example of how professional ethical theorists can determine whether a specific action
is ethical or not.
ACTING ONLY FROM DESIRE
As far as the other approach that one may take to an action in determining if it is ethical—if a
person acts strictly from desire, then he is acting more like an animal inasmuch as there is no
moral reason to take the course of action. The question should be not what action will fulfill the
inclinations, but what fulfills the sense of duty or obligation.
ETHICS OF VIRTUE
There is one more class of person, or perspectives used by a person, in determining whether
an action is ethical, and which has been called the ethics of virtue, or as some prefer, ethics of
character. The first word that comes to mind too most is ―honesty.‖ While the classical sense of
virtue is not necessarily confined to honesty, it is most descriptive for this discussion. Accoun-
tants have the responsibility to always respond truthfully and there is little doubt that this is a vir-
tue that is mandatory for a professional accountant.
Another virtue can be loyalty. However, is loyalty compatible with good, solid (some say
―hard-nosed‖) auditing(for example) practices? This points out that some ―virtues‖ can conflict.
How much loyalty to a client should an auditor have? Should an auditor warn a client of an audit
problem before the audit report is filed? It is easy to see the magnitude of this problem.
40
While it certainly would not hurt any professional to spend the time to become better edu-
cated in philosophical studies of ethics with its many ramifications; as a practical matter, most
people do not think about the principles to be used in determining whether an action is ethical.
Most people simply go by their ―gut-feelings,‖ their intuition or their own personal feelings.
Some simply go completely by what their training has provided them to consider.
Since people in the same vocation or endeavor have various reasons and motives for acting
as they do, there must be a published code of ethics for any profession if for no other reason than
uniformity.
DETERMINING THE PROPER ACTION
Once these steps have been taken, then the options available must be evaluated to determine
which would be correct. To oversimplify this evaluation, there are several ways to determine the
right action, but many experts break it down into only four steps:
1. Is the action that appears correct, beneficial to the parties concerned? Sometimes at this
point it would be helpful to use the ―smell‖ test, i.e., if the action doesn‘t ―smell‖ right,
then it probably isn‘t.
2. Is the action to be taken, fair to the parties involved?
3. Is there a responsibility to perform the action because of a prior commitment or promise
made?
4. Is it legal?
The proper evaluation of these options is the heart-and-soul of ―Ethics.‖
DEALING WITH RIGHT OR WRONG
Obviously, ―Ethics‖ can be said to deal with right or wrong. Believe it or not,
Nearly everyone has a(n) (ethical) set of beliefs as to what is right or wrong
and these beliefs do not necessarily remain the same among all persons.
For instance, abortion, capital punishment, and adultery can be good or bad, right or wrong,
or acceptable or unacceptable, to a person or a group of like-minded persons. Cheating, stealing,
and not keeping promises, or abusing children, elderly persons or animals are usually considered
as ―wrong‖ or ―bad.‖ These all constitute moral beliefs, and if one were to write down all their
similar beliefs, they would, in essence, create a personal code of ethics.
The primary subject of ―ethics‖ is human actions, referring specifically to any action that is
deliberately taken. If a person thinks about a particular action and then chooses to take this ac-
tion, then it is a deliberate action and if the person has any control over this (these) action(s) –
then they are held responsible for their actions.
PERSONAL RESPONSIBILITY
In today‘s society, this ―personal responsibility‖ is becoming an ―ancient‖ belief that is not
―relative‖ to today‘s situations. A mother drowns her children, but it is ―not really all her
41
fault…‖ A sniper kills innocent people at rest stops, but it was only because of the (fill in your
own reason)… A corporation goes bankrupt, leaving many vendors, employees and investors
with empty pockets, because an accountant employed by the company ―went along‖ with the de-
sires of the company President to over-inflate the value of high-end inventory items in order to
show the profit to the Board of Directors that the President had promised - but the accountant is
not at fault because he was just doing what his boss wanted him to do… etc., ad infinitum.
True, the actions of individual humans are not the only subject regarding ethics that must be
considered. The activities of a group of individuals can be called ―social practices‖ if one delves
deeply into the study of Ethics. A practical example would be an individual using insider infor-
mation to buy certain stock or in the case of a stockbroker, to notify his clients of a probably de-
crease or increase in the value of their stock because of ―insider information.‖
Remember the earlier discussion of Equity Funding. The stock analyst who was first made
aware of this situation also faced an ethical problem. The analyst had been informed of the situa-
tion over lunch with an executive of Equity Funding. The analyst did some quick checking and
as a result, was convinced that the executive was telling the truth. He contacted many of his
clients and recommended that they get rid of their Equity Funding holdings. As a result of this
action, the New York Stock Exchange charged the analyst with violating exchange rules with
information about Equity before regulatory authorities made it public.
Ethical questions arose, naturally. Insider trading is a ―general practice‖ and his using this
information was an individual action. One question that could be asked – and frequently was – is
―What was the analyst to do?‖ When he became aware of this information he was not able to
completely verify the information, but he felt that it was his duty to his clients to pass on the in-
formation that he possessed, just in case… Ethically, was it not his duty to protect his clients? If
he had not notified his clients and it later was disclosed that he had known of the situation, would
he not be susceptible to legal action? And another related ethical question could be ―Why did
the executive wait for three years before exposing this situation.‖ [There actually is an answer to
this question—think about it and then check the last sentence in this Chapter]
INTEGRITY
The Code of Ethics for any profession will state in some fashion or other, that the member
should perform with the highest sense of ―integrity,‖ of words to that effect.
The acknowledged definition of integrity is ―firm adherence to a code of
especially moral or artistic values.‖
Many ―old-timers‖ would ask, ―Is it proper?‖ when deciding what to do in many situations.
When asked how a person could know if it was ―proper,‖ the answer usually was, ―You just
know.
JUSTIFICATION
Suppose you were 16 with a driver‘s license, and you had been looking forward for months
to taking Susie (or Ralph) to the movies in the family car, all by yourself. Your father had
agreed to let you use the car to take (Susie or Ralph) to the movies when you got your license.
42
When the day came and Susie (Ralph) had agreed, you asked your father for the car keys, but he
says that you cannot have the car. You are understandably upset, and you cannot understand
how he can go back on his word. You father can then say that he is not obligated to give you the
car, therefore his belief is not justified or he should justify it to you. Maybe he just doesn‘t feel
like it right now.
This justification probably wouldn‘t fly to your satisfaction, because he did ―promise.‖ And,
people should always honor their promises (a basic of Ethics). This could mean that any promise
is not worth much – business deals will fail, marriage will come apart, and the world will go to
wherever in a handbasket.
However, what if he said that the XX@&$!)**&% thing blew the carburetor today when he
was driving home and he can‘t get the parts until Monday. Now, there‘s a reason for not honor-
ing the promise. In other words, there is justification. This proves that
Moral beliefs are right or wrong, correct or incorrect, and they can be
justified if there are good reasons.
IS THIS GOOD FOR ME?
It is not coincidental that this consideration would be the first to be discussed, as that is typi-
cally the first thing that goes through the average person‘s mind. This is not always true, -
Mother Theresa rarely, if ever, thought of herself first. For the rest of us who are not approach-
ing Sainthood, if you can actually perform an action that benefits yourself, can you think of a
better reason for doing it?
Of course, this is applicable only if it is ―meaningful‖ work – usually defined as work that
can be beneficial to the person. Most people have a need to be productive and to work towards
that end (some don‘t, but they wouldn‘t be professionals), so therefore, work is good for us all.
Conversely, if an action hurts oneself (not necessarily physically) then that is a great reason
for not doing it. This can be overdone frequently, as some people seem to think that any actions
that are beneficial to them must therefore, not be the right thing to do. Of course, this is silly, as
if a person doesn‘t consider or concern himself or herself with an action that benefits them, then
who will? You cannot go through life without looking out for yourself.
This concept can be overdone, as evidenced by taking a walk down the mall and note how
many large, overweight people are in evidence. Not in every case, of course, but generally it can
be accepted that when it comes to food, some of them look out for themselves just a little too
well.
A good rule to follow in determining if an action is good for you is that in most cases,
There can be justification that an act can be good simply by showing that it is
good for you.
43
HOW DOES THE ACTION AFFECT SOCIETY?
The next step is actually to take a step back and look at the ―big picture.‖ Is this action not
only going to be good for me, but is it going to be good for everyone (society) as a whole?
One outstanding example of determining what is good for society, as often quoted in such
discussions, involves Tylenol and Johnson & Johnson. When Johnson & Johnson were made
aware that some of their Tylenol bottles had been tampered with and it was nearly impossible to
determine just how many bottles were involved, they immediately made the judgment call to re-
call ALL Tylenol from the shelves of the many stores and warehouses, causing the corporation
untold millions of dollars in profit. This was a decision based upon whether the action would
affect society, and fortunately for Tylenol users, this was the right decision.
An interesting point is that the business press solemnly but loudly (in some instances),
prophesized that Tylenol would never regain its market prominence. It did.
IS IT FAIR, JUST AND PROPER?
Remember as a child, the many times that things would happen that just weren‘t ―fair?‖
Even as an adult, a situation will arise that just does not seem ―fair.‖ When voiced, the objection
was usually overcome with the statement (in some fashion of other) that ―life just isn‘t fair.‖
While this may seem logical to an adult to some degree, for a child it still is not ―fair.‖
Of course, all people should be treated equally unless there is some relevant difference. This
can be illustrated by the way that a large (actual) European company was managed for many
years. It had only one stockholder, who was designated as CEO and Chairman. In an effort to
appear ―Democratic,‖ the CEO designated a ―Manager‖ in charge of each major division within
the international firm (this would be equivalent to a Chief Operating Officer in most corpora-
tions) as a member of the Operating Management. Great pains were taken to make sure that each
Manager was equivalent. However, there always has to be a decision-maker, so all Managers
were considered as equal, but they would then elect one Manager as ―more equal than the others‖
and who would report directly to the Chairman. This system survived for many years but upon
the death of the sole shareholder, his heirs transformed the operation into a more-typical compa-
ny-management style.
Just like ―cream always rises to the top,‖ there always seems to be one person who is ―more-
equal‖ than others. And that is probably a good thing.
IS THERE A RIGHTS VIOLATION INVOLVED?
Every American has the right to be treated ―equally.‖ And, we all have the right to life, liber-
ty and the pursuit of happiness, and, to be technically correct, to property. However, the gov-
ernment grants us certain rights and when these rights are infringed upon, then we are protected
by laws and regulations. The use of coercive marketing techniques and deceptive advertising is
considered as a violation of our rights to liberty. Even the laws that enforce the rights are often
considered as a violation of a business entrepreneur to do business.
Certain rights have become known as ―entitlements.‖ These entitlements include the right of
a child to be educated, for instance, but the means for this education must come from others who
are obligated to provide this right. Healthcare for everyone, jobs for everyone, housing for eve-
44
ryone, etc., are not ―rights‖ per se, but in certain situations, these rights could be assumed. If
they are so assumed, it is the right of the taxpayer to know whom, how and how much these
―rights‖ can affect the rights of the taxpayer to keep and hold property.
More pertinent to this discussion is the right of a purchaser of stock in a corporation to be
provided with accurate financial information regarding the corporation.
So, if a proposed action treats all persons involved equally and fairly and there is no violation
of their rights, then this is a reason to continue with the action. Conversely, if the rights of
another would be violated, even to a small degree, then this is a big reason not to take the action.
HAS THERE BEEN A PROMISE MADE?
A promise is a commitment, and if one has made such a promise/commitment, then one
should do all in their power to honor the promise/commitment. This is an inescapable reason to
pursue the course of action contemplated.
In a discussion of ethics, however, this must be taken a step further. Is there any prom-
ise/commitment beyond those that were agreed upon by the parties involved? Implied promises
are generally a distinct and very important part of most transactions. For instance, if one pur-
chases a set of golf clubs, there is an implication that the club shaft will not break or bend if the
club is used properly and for the task for which it is designed. Those who purchase insurance
products do not expect that when the insurance is needed, the ―small print‖ will void their
agreement with the insurer.
It is an inherent trait of civilization that promises between persons are kept -
and most of the promises are implied. What would happen to commerce if there were no im-
plied agreements between an employee and an employer, that the employee would show up for
work every working day?
But what if you borrow some anti-freeze for your car from your neighbor with the promise to
return what is not used. He later then asks for you to return what was not used as he had discov-
ered that a cat would readily drink anti-freeze, and that when they do, they assume room temper-
ature. And further, the cat belonging to the person across the street has been intimidating his
poodle, and he is going to solve that problem, ―once and for all.‖ Do you break your promise in
this situation, knowing what the result of keeping your promise will be that harm that will come
of returning the anti-freeze would outweigh the promise? (This may be arguable with some that
really, really, hates cats – but you get the point.)
ETHICS IN FINANCIAL PLANNING
Financial planning is an area of ethics that affects both insurance agents and those with se-
curities licenses and ethics are such an important part of financial planning that it should be in-
cluded in the chapter on Ethics. Common sense would dictate that the same level of ethical con-
duct that is so important in insurance sales and service, would also be appropriate to financial
planning.
45
As mentioned in the story at the beginning of this text, there are those who call themselves
"financial planners" even though they do not have the experience, education or training to justify
that title. Unfortunately, this creates problems for those professionals who have spent countless
hours in study and years of experience in order to become real, professional "financial planners."
For instance, it is extremely difficult for a person that only sells and services life insurance prod-
ucts to actually be a financial planner.
RULE: AN INSURANCE AGENT WITH NO FINANCIAL PLANNING EDUCATION
MUST NEVER, EVER, REPRESENT HIMSELF AS A FINANCIAL PLANNER.
EDUCATION FOR FINANCIAL PLANNING
The American College awards Chartered Life Underwriter (CLU) designations, along with
Chartered Financial Consultant (ChFC). These designations are the top professional designa-
tions that includes education in other insurance fields, not only financial planning. The most
recognized financial planning are those leading to the Certified Financial Planner (CFP) and the
aforementioned ChFC designation.
There are two organizations in particular, that set the standards for education and ethical
conduct in financial planning, the Financial Planning Association (FPA) which consists of DFPs
only; and the College for Financial Planning. Each of these organizations stress the ethical need
for the insurance agent to consistently identify himself as an insurance agent, to identify the
company that he represents and to identify the nature of the sales call that the agent is making.
CONFLICTS OF INTEREST
Conflict of interest can be the most serious of ethical breaches—and is also
considered by most as the most serious of legal breaches.
As an insurance agent moves from life underwriting to financial planning, or from the mar-
keting of securities to financial planning, a broader scope of ethical responsibility must be ac-
cepted. This means, among other things, that an insurance agent that is qualified to give advice
or sell securities and tax-sheltered investments as well as life insurance, must not only be aware
and abide by ethical requirements for insurance marketing, but also aware of the ethical require-
ments and the rules and regulations for securities salespersons.
An agent who is subject to the Investment Advisors Act of 1940 who charges a fee for ser-
vices rather than a commission is considered as a fiduciary of the client. This means that the in-
surance salesperson is required to disclose to the client all material information that pertains to
the services provided—which may conflict with the agent's status as a fiduciary of the customer.
The agent has the duty of loyalty and care to the client, and the same duties are owed to the in-
surer. Obviously, a conflict of interest hazard. This problem of conflict of interest grows if both
a fee for service and a commission on the sale are charged.
46
THE INVESTMENT ADVISERS ACT OF 1940
Financial planners who engage in rendering investment advice as part of their services will
probably fall under the SEC and Investment Advisers Act of 1940. This Act has many important
features, but for the purpose of this discussion the requirements that those who are in the busi-
ness of giving investment advice and who receive compensation for doing so, the important part
is the requirement that those who give investment advice and receive compensation for doing so,
must register as an investment adviser with the SEC and conform with certain standards of ethi-
cal conduct (as defined in the Act).
Without going into further details, the SEC's position as applied to a financial planner or in-
surance agent, means that if his services involve rendering advice or analysis concerning securi-
ties—he is then, unarguably, an investment adviser. Therefore, the agent is subject to the Act's
registration and standards of conduct provisions. Because of the nature of the relationship be-
tween the advisor and the client, the ethical standards are quite high.
Among these standards are prohibitions against using any fraudulent, deceptive or manipula-
tive scheme or device in dealing with prospects of client, and engaging any transaction, practice
or course of business that is intended to deceive a prospect or client.
Interestingly, the provisions of the Act applies not only to registered investment advisors, but
to any person who meets the description of investment advisor, regardless if the person is or is
not registered with the SEC.
DO WE KNOW WHAT ETHICS IN INSURANCE REALLY ARE?
Even after reading the previous pages, the question remains—do we really know what ethics
are, and what determines what is ethical and what isn't? If thousands were asked these questions,
there would be a plethora of answers, and therein lies the dilemma. Actually, our own ethics are
determined by our own set of moral standards, and there is no "engraved in stone" standard that
can possibly cover all situations.
Ethics principles are nice to talk about, but actually they are not very specific and in most
cases, there is no one enforcing the moral codes. Therefore,
Ethical behavior is the result of individual choice.
INSURANCE ETHICAL CHOICES - EXAMPLES
John and Mary are married with 2 small children. John works and Mary is a homemaker and
full-time mother. Their funds are rather limited but they feel they can afford $400 to spend on
life insurance. One agent shows them a $200,000 term insurance policy, but another agent
shows them a while life policy with a face value of $25,000. All things being equal otherwise,
which agent is correct?
47
Actually, they both are probably correct, as these are two adults who can differ between per-
manent Whole Life which will allow them to start a savings program for their kids education and
still have some cash in case of premature death of the provider.
Term insurance will provide a much larger death benefit if John dies at an early age, and with
$200,000 Mary could probably stay at home until the children gets older, at which time she
would be able to get a job. And there is the conversion to a permanent plan at a later date if John
becomes insurable.
The choices are rather clear, so if everything is discussed correctly, the couple will make
their own decision.
Now, let's say that John and Mary purchased the Whole Life policy and they had not heard
about the term policy. A friend of a friend is an agent who told them about the term insurance.
So they contacted their agent, told him that an immediate death benefit was more important to
them than the savings feature. Now comes the dilemma. If the agent replaces the permanent
policy, is he wrong?
Forty years down the road, if John and Mary are still clicking along, then they may have
wished that the agent would have convinced them to purchase the Whole life policy. Is the
agent's actions still moral and ethical? Who can say if one is more right or wrong. The error in
this situation is that the first agent did not give them an opportunity to look at two alternative so-
lutions and decide what helps them the most.
If an agent is selling to a young couple and he knows that if it were him, he would want term
insurance, so that is what he sells to the couple. One of the justifications is that if there were a
death claim, he would much rather deliver a large policy, and he might have a hard time living
with himself if he had not sold a larger face amount term policy.
Then another factor arises—commission. Much less commission on a term policy, much
less. How does that rationalization account for that? Can an agent honestly say that commis-
sions have little or nothing to do with what he sells? Now we have a situation that boils down to
a conflict of interest.
Now the Code of Ethics comes into play, if there is a "conflict of interest situation, the inter-
est of the client must be paramount." End of discussion. Forget the down payment on the
Porsche, buy a Mustang…
Answer to previous question in respect to an executive not reporting the situation earlier: He
wanted to wait until his children got out of their expensive private school as he knew he would
lose his high-paying job when the whistle was blown on the operation. Was he ethical in want-
ing to protect his children's education by keeping his mouth shut? (He ended up as Chief Un-
derwriter for a small life insurance company on the East Coast who knew the story. His kids
went to public schools there…)
STUDY QUESTIONS
1. Ethically, an action may be justified if it
A. brings more happiness than unhappiness for more people.
B. brings more unhappiness than happiness for more people.
C. sounds good and at last three other persons agree to it.
D. causes no tears.
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2. "Firm adherence to a code of especially moral or artistic values" is the definition of
A. integrity.
B. morality.
C. legality.
D. adherence.
3. There can be justification that an act can be good
A. if the act does not do you any good.
B. by showing that it is good for you.
C. if it is inexpensive and it hurts no one.
D. if it is legal and popular.
4. It is an inherent trait of civilization that promises are kept
A. even if they are fallacious.
B. between merchant and customer.
C. and most of the promises are implied.
D. but only when so directed by a ruling power.
5. The most serious of ethical breaches and also considered as the most serious of legal
breaches, is
A. intemperance.
B. falsification of documents.
C. conflict of interest.
D. bearing false witness.
6. Ethical behavior
A. always is the result of years of discipline.
B. is the result of individual choice.
C. affects only the upper class.
D. is not necessarily mandated in insurance transactions.
7. Financial planners who engage in rendering investment advice as part of their services
A. are probably regulated by SEC Circular 1036-9 (Unethical Acts of Financial Planners).
B. need not be licensed either by the SEC or the Insurance Department.
C. will probably fall under the SEC and the Investment Advisers Act of 1940.
D. are not allowed to operate in California.
ANSWERS TO STUDY QUESTIONS
1A 2A 3B 4C 5C 6B 7C
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CHAPTER FOUR - VARIABLE ANNUITIES & VIATICALS
TAKING ANOTHER LOOK AT VARIABLE ANNUITIES
Since many insurance agents who are reading this text are also licensed to market securities,
for purposes of this discussion, it is assumed that the student is versed somewhat in the inner
workings of Variable Annuities. This is a product that has been accused of being abused as
much, if not more so, than any other insurance product. Because of these endless sales abuse
accusations, the nation's securities cops have proposed tightening the rules regulating annuity
sales. Insurance companies, who have sold Variable Annuities for years, do acknowledge some
abuse but maintain that they are now under control and sales abuses have been stringently dealt
with. There is supporting evidence to show that between the state regulation of insurance com-
panies that market this plan, and the SEC and NASD requirements, abuse has been kept to a min-
imum recently. Still there are those whose shrill cries gather attention once in a while.
It is easy to understand why this product as caused such dissension as it is the best of both
worlds in many ways—the stability of the insurance industry and the ability to share in advances
in the national economy.
It is rather amusing to those in the insurance industry to read some of the loud objections to
the plan that have sprung up on the internet. One of the accusations is that since insurance bro-
kers and securities brokers are receiving these huge and onerous commissions. These commis-
sions often are pegged to the length of the surrender period—if the surrender period is 7 years,
then the commission is 7%. This may be so in a few instances, but simply put, the average
commission paid is between 4% and 8%. Substantial, but too high?
Those who are so vociferously objecting to these "high" commissions appear to be those who
make a living selling only securities. With the modern economy growing and the market on a
pogo stick ride, some stability that can be obtained by the use of Variable Annuities should be
most welcome.
ADVANTAGES OF VARIABLE ANNUITIES
The primary benefits of variable annuities are:
death benefit;
living benefits;
tax deferral;
liquidity;
tax-free transfers;
performance;
probate avoidance;
potential for a guaranteed lifetime income.
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In all fairness to those who are denigrating Variable Annuities, stack these benefits up
against mutual funds and compare ALL of the benefits.
USING VARIABLE ANNUITIES
That is not to say that Variable Annuities are not somewhat complex. It is a marriage of an
insurance product and a securities product—often compared to crossing a horse with a donkey
and you get a mule, but a mule is much superior to horses or donkeys for strength and endurance.
Looking at the product as to how it works, a Variable Annuity is, in many cases, an "uninsured"
securities/insurance product that provides investment options— much like mutual funds—for
long term investors, who want an extra way to save for retirement. Further, these investment op-
tions (sub-accounts) are packaged within a Variable Annuity on a tax-deferred basis.
Variable annuities are usually considered as strictly supplemental retirement investments.
Therefore, to be ethical (and stay out of trouble), a prospect or client should not purchase a Vari-
able Annuity unless they can answer "yes" to these three questions"
1. Do you contribute the maximum amount allowed each year in your 401(k) or other
workplace retirement plan every year?
2. Do you contribute the maximum each year to an Individual Retirement Account
(IRA)?
3. If married, does your spouse take full advantage of items one and two, above?
RULE: BE AWARE OF WHAT THE MAXIMUM CONTRIBUTION THAT CAN BE
MADE TO EACH OF THESE PLANS EARLY IN THE CONVERSATION AS THAT
WOULD DETERMINE WHETHER A VARIABLE ANNUITY IS ETHICALLY
FEASIBLE.
This is not to imply that the Variable Annuity is the only other investment that can be made,
as each situation is different (obviously). The point is that before one should even start talking
about a VA as an investment, these questions should be answered.
Be prepared to discuss the additional fees as in many cases Variable Annuities may cost
more than other investments because of the fees. Often there is a comparison between the return
from a Variable Annuity and from mutual funds. Of course, there is not the tax advantage of
VAs, regardless of how loudly the naysayers insist that because of the fees, VAs cannot perform
as well as mutual funds. However:
Not only have annuity interest rates become competitive with other investment
products, but annuities also enjoy deferral of income taxation on earnings.
It is also interesting to see how those anti-Variable Annuity forces treat this as their predo-
minant weapon, it seems, is harking on the fees. One organization on the internet insists that the
average is 2.2 percent of the assets each year. Where this came from is unknown, as recent fig-
ures indicate that it is much like 1.3%.
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As long as we are talking about "money-monkeying," often securities salespersons proclaim
that the annuitant will owe ordinary income taxes on every dollar of annuity withdrawals. And
then they run some figures showing how much the investor would save if he only had to pay cap-
ital gains taxes.
So, let's take a look at something that has been "forgotten" in this discussion:
VARIABLE ANNUITIES EXCLUSION RATIO
The ―Exclusion Ratio‖ applies to all annuities, but Variable Annuities have their own situa-
tions and rules—obviously because the exact amount of payout cannot be predetermined exactly
as it can with the fixed annuity. The amount of each Variable Annuity payout can fluctuate
which makes it impossible to determine the total benefits expected. However, assume an Indi-
vidual had paid premiums of $90,000 and expected to receive payments for 20 years. Dividing
$90,000 by 20 years, results in $4,500 per year—representing return of premiums only. Then,
for example, if the earnings on the account resulted in the annuitant receiving $6,000 for one
year, $1,500 (―interest‖ paid over and above the $4,500 base) would be taxable. If this annuitant
received only $3,000 for one year, none of it would be taxable since it all represents return of
premium, no interest. With a Variable Annuity, the exclusion could be recalculated when pay-
ments change, following IRS procedures.
Did you pick up on the statement that the portion of the payments that represents return of
premium (at no interest) is non-taxable?
RULE: IF ONE PRODUCT IS COMPARED TO ANOTHER PRODUCT, MAKE SURE
THAT IT IS A LEVEL FIELD AND NOT "APPLES-AND-ORANGES."
Another point that these harbingers of doom (running out of descriptive terms) bleat is that
beneficiaries will be saddled with paying capital gains tax on any profit that the annuity generat-
ed. This is (? ) a big disadvantage as if the money had been in mutual funds, (for instance) the
kids wouldn't have to pay taxes because of the step-up in basis. Okay – pay now of pay later.
And while there is some point to the heirs having to pay capital gains taxes, if the money comes
from an annuity, then ordinary income tax would be payable only on, (to repeat) the gain, not on
the original premiums that were paid. Interestingly, an agency with a web page on the internet
stated that if an annuity was funded with $50,000 and at time of annuitization it had grown to
$75,000, the heirs would owe tax on the $25,000 in profit. Further, it is contended that if the
money had been placed in taxable mutual funds, because of the step-up basis, the kids would get
that $25,000 tax free. Kowabonga – big tax advantage. The problem is that during the period of
growth, taxes were paid on the growth. Pay now or pay later…
In attempting to pooh-pooh the death benefit, it was stated that the death benefit was "point-
less or superfluous." Bet it isn't pointless or superfluous to the heirs!
With a Variable Annuity, an insurer guarantees that heirs will receive at least the contribu-
tions made into the annuity, less any withdrawals, even if the account later drops in value. So,
if you invest $100,000 in an annuity and the account is worth only $80,000 when you die, your
heirs still receive $100,000. That is really painting a death mask on the product. But be pre-
52
pared as there are those scholarly types that comes up with formulae which indicates that the
guaranteed minimum death benefit at 5 or 10 basis points per year, depending upon the wording
of the death benefit provision. Quoting unintelligible formulae (what would you expect from a
college professor…) it has been trumpeted that the death benefit is overpriced.
Okay, maybe so. The old story comes to mind where a prospect asks a life insurance agent
exactly how much premium should he pay for life insurance so that he will pay in premium only
what he gets in death benefit. The agent says, "I can tell you exactly how much you should buy.
All I need is your date of birth and your date of death." 'Nuff said.
Before we quit discussing the advantage of the death benefit, there is one feature that should
always be disclosed—the death benefit may expire at annuitization. This feature should always
be disclosed so check it out. Depending upon the annuity and the company, this may be avoided
as the company should have some method to keep the death benefit in force. After all, who
writes Variable Annuities? LIFE insurers.
However, if the annuity owner is not happy, it may be possible to transfer the money direct-
ly into another annuity company without triggering taxes (a Section 1035 exchange). Tax laws
change, but usually if you transfer from one plan to a like plan, there will be no taxation. How-
ever,
RULE: ALWAYS KEEP ON TOP OF TAX LAWS THAT AFFECT THE PRODUCTS
YOU MARKET, IN PARTICULAR (IRS TAX CODE) SECTION 1035 EXCHANGES.
Therefore, let us take a longer look at annuity 1035 exchanges:
ROLLOVERS (1035 EXCHANGES)
This subject has been approached previously, but deserves more detail and some repetition.
Any income tax on an annuity or insurance contract that has been distributed from a qualified
plan can be postponed by converting the annuity or insurance contract to a ―nontransferable‖ an-
nuity immediately (according to recent action by the IRS, although within 60 days is still in the
regulations – but why take a chance?). Current taxation on the qualified distribution can be
avoided if it is rolled over into a regular IRA.
Once the funds have been deposited into the IRA, taxes will not have to be paid on the rol-
lover until the IRA starts to distribute its assets. Any lump sum distribution will be taxed as or-
dinary income, and any annuity distributions will be taxed as previously discussed.
A partial distribution to an employee of the funds held in their account may be rolled over in-
to a regular IRA unless (1) the employee reaches age 70 ½, (2) payments will be made for 10
years periodically or for the life expectancy of the employee, or (3) the amounts are not included
in the gross income in the absence of the roll over.
53
A nonqualified annuity may be exchanged for another annuity tax free, provided:
The same person must be the obligee or obligees (insureds) under both con-
tracts.
Exchange must be a ―like kind‖ transfer of one contract for another contract, so
exchange proceeds are transferred directly between the issuers or the old and
new contracts. If proceeds are received by contract owner in cash, the transac-
tion will be treated as a taxable surrender of existing contract, and will proba-
bly be treated as a taxable surrender followed by purchase of new contract.
The IRS has held that the direct transfer of an entire annuity contract into another preexisting
annuity contract qualifies as a tax-free exchange under Code Section 1035.
The following rule is not only a rule to keep you out of trouble, but it is also definitely a
marketing aid. For instance, depending upon the annuity, the annuity owner may be able to
transfer to another like annuity but there may be penalties (surrender charges) involved.
RULE: NEVER, EVER, ENTICE AN ANNUITY OWNER TO TRANSFER TO
ANOTHER ANNUITY—PARTICULARLY WITH ANOTHER COMPANY—UNLESS
ALL PENALTIES ARE KNOWN TO ALL PARTIES.
There are certain situations where a second look may be needed, or at least a more detailed
explanation to the client, if marketing a Variable Annuity. If a Variable Annuity is to be used in
an IRA, make sure that the client fully understands that the tax advantages of a Variable Annuity
loses some of its charm as the IRA has tax advantages on its own.
If a person plans on taking out a mortgage loan or equity loan on their residence in order to
fund a Variable Annuity, be careful, be VERY careful. Regulators usually look askance at these
situations.
If a Variable Annuity has a bonus feature, sort of a "blue-light special," be aware that regula-
tors are not happy with these situations. There can be higher annual costs and/or a lengthened
surrender period and you will have to do a lot of heavy explaining as to the advantages of re-
placement. Most states have replacement forms that ask some hard questions. This is not to say
that you can never sell a bonus plan, just be careful, meticulously so. You may have to explain
exactly why this is good for the consumer and if you do not have an iron-clad reason, forget the
sale.
If your insurance carrier offers a stepped-up death benefit rider, make sure that it is ex-
plained in that way to the consumer. It is NOT "another kind of Variable Annuity."
Then there is the guaranteed benefit rider, which is usually available only on some of the
older plans. Usually it is only available if the annuity is annuitized under the older contracts, but
it does allow for a guaranteed stream of income for the life of the annuitant (something that is
unavailable with mutual funds…)
54
It is not a good idea to represent a Variable Annuity as a "no-load" product because if the
annuity is cashed in early, there are penalties, some of which can be rather severe. If it is com-
pared to, for instance, a "no load" mutual fund, and the fact that the expense factor pays for the
commission to the salesperson while the commission of the mutual fund salesperson is invisi-
ble(?), somebody has to pay for the efforts of the mutual-funds salesman. Somebody has to pay
for the large homes in the gated communities in which they life and the BMWs that they drive…
Remember, there can be a severe tax penalty if withdrawals from an IRA (funded by a Vari-
able Annuity or other type of plan) are effected prior to the annuitant reaching age 59 ½.
IRS PENALTY
No matter what type of annuity you purchase, it is subject to a 10 percent IRS penalty for
withdrawals of growth of income made prior to age 59 ½, and there ―ain‘t no easy way‖ to avoid
it. No penalty is imposed on one's principal, i.e. the money put in by the owner is the owner‘s
money.
Didn‘t say that there was NO way to avoid this penalty prior to the age of 59 ½. There just
happens to be 3 ways to avoid it:
1. The annuitant (or contract owner) must be dead.
2. The contract owner must be disabled.
3. Of course, the contract can be annuitized.
It makes no difference how old the annuitant (or owner) of the contract is, if they die then
there is no penalty. Also, the IRS Code states that the penalty is waived if the annuitant (or own-
er) is disabled. Generally, it must be the death or disability of the annuitant, not the contract
owner or beneficiary, except where the contract is owner-driven, in which case all IRS penalties
will be waived upon death or disability of the owner.
If the contract is annuitized, it will avoid penalty, but such annuitization must be elected by
the contract owner within one year after investing in the annuity. The age of the owner does not
have to be 59 ½, indeed it is irrelevant.
The final way in which the 10 percent IRS penalty can be avoided is the contract owner be-
ing age 59 1/2 or older.
Because of these penalties, annuities are usually recommended for younger people unless it is
part of a retirement plan such as an IRA or pension plan or profit-sharing plan. Of course, there
is always the exception of the person who has sufficient funds so that they would not have to
touch the funds in case of an emergency. Annuities are ideal candidates for the investor who is
near or past age 59 1/2.
Unless the contract is ―owner-driven,‖ the owner can be any age, from new born to 30, with-
draw funds if they have to go into a nursing home or if they are diagnosed with a terminal illness.
Some Variable Annuities offer "living" benefits, such as guaranteed accumulation benefits and
guaranteed withdrawal benefits, such benefits would be available without the annuitant having to
annuitize. The guaranteed accumulation benefit promise that at a certain future specified date
the accumulation value will equal the original purchase price, even if the market was down. The
guaranteed accumulation benefits guarantee that the accumulation value will equal the original
purchase price in a down market, and would be stepped up in an up market which would be
55
locked in to automatically increase the original purchase price. Other similar benefit may be of-
fered.
Other annuities, such as Equity Indexed Annuities (EIAs), may work better if there is great
concern about the market bottoming out. Without going into great detail here, these EIAs may
solve the problem of consumers who want to take advantage of the increase in the market, but
wants a floor in case the market tanks. The EIA is an insurance product generally, although
there are brokers and advisers that market the product.
The NASD has proposed changes in marketing Variable Annuities which include specific
requirements for sales practices including new suitability, disclosure and supervision provisions
along with enhanced sales force training. The NASD cited the 80 Variable Annuity sales prac-
tice disciplinary actions over the last two years as the impetus for this increased investor protec-
tion warranted. Some of the changes that NASD has proposed should definitely be encompassed
within the new rule changes:
A separate risk disclosure document must be provided to the investor prior to any sale and in
addition to the prospectus (too often mailed to the client after the sale) because a potential inves-
tor is significantly more likely to read a brief and an easy-to-read disclosure document containing
salient points regarding the mechanics of the instrument. As a result, such a document is an im-
portant element in the prevention of sales practice and suitability violations.
A comparison document must be made available indicating at least two low-cost alternatives
to the Variable Annuity. This comparison would form the basis of review of the sale or ex-
change by the supervisor in the most tangible means. The NASD strongly feels that unless such
comparisons are made available, investors cannot make reasonable and informed decisions re-
garding the purchase or exchange of the Variable Annuity product.
The Principal review should include a periodic review of the associated person's production
report for Variable Annuity purchases and exchanges. This would allow the registered Principal
to detect possible patterns of sales practice violations and other potential abuses that may not be
revealed on other reviews conducted after each sale. Members should always review both rec-
ommended and non-recommended Variable Annuity transactions.
Hypothetical Illustrations used must not be misleading. Using mutual fund illustrations us-
ing the net asset value (NAV) of the parallel retail mutual fund should not be used instead of the
accumulated unit value (AUV) of the Variable Annuity sub-account in illustrating hypothetical
performance as the higher expenses inherent within the Variable Annuity would be misrepre-
sented by using the lower cost mutual fund. Training programs, policies and procedures should
ensure that hypothetical illustrations fully and fairly disclose all of the material features of varia-
ble annuities and sub-accounts.
56
VIATICALS
This section discusses Viatical sales – an area of insurance marketing that is "fraught with
danger." (It is combined with the discussion on Variable Annuities only because the two sub-
jects can create a Chapter…)
An attorney (Donald Kohtz)—naturally—tells us that "Viatical" originates from the Latin
word "viaticum" -- provisions for a journey. "A viatical settlement is an act by a person who is
terminally ill of cashing in a life insurance policy to pay for the necessary associated illness,
medical expenses, and final wishes. This terminally ill person contacts a viatical agent who bids
the life insurance policy on the terminally ill person to the many viatical settlement companies.
The package that is sent out for bids includes the terms of the life insurance policy as well as the
medical prognosis of the terminally ill person. The viatical settlement company that is awarded
the bid agrees to pay 50% to 80% of the face amount of the policy, varying according to the
gravity of the terminally ill person's condition and life expectancy. The company also pays fur-
ther premiums. In turn, the viatical settlement company sells the terminally ill person's life in-
surance policy to an investor who then becomes the policyholder as well as the beneficiary and
assumes payment of the premiums of the policy. The purchase takes place when the terminally
ill person is expected to live 24 months or less. Upon the death of the terminally ill person, the
investor will receive 100% of the life insurance policy's face amount from the insurance compa-
ny. The sooner the terminally ill patient dies, the higher the investor's return. While returns of
15% to 20% per year are typical for investors, the return can be substantially higher if the death
of the individual was diagnosed as terminally ill. (Dictionary of Insurance Terms, 3rd Ed.)
Say, for example, that John Doe has a $100,000 policy when diagnosed with terminal can-
cer. A viatical company/operator may offer $50,000 to purchase the policy and be designated as
its new owner (beneficiary). The viatical agent/company would then offer this $100,000 policy
to a potential investor for $68,000. The estimated "term" (length of time before collection of the
policy's face value) is usually the life expectancy of John Doe. The viatical operator would im-
mediately pocket $18,000 from this transaction. T he investor stands to gain by paying $68,000
for a policy worth $100,000.
Typically, Viaticals are executed by recruiting applicants who already have a preexisting
terminal illness, generally AIDS or cancer. Viatical settlement brokers, licensed agents, and rep-
resentatives of viatical settlement companies, recruit applicants to apply for multiple "instant-
issue" policies. They misrepresent the truth and answer "no" to all of the medical questions.
Healthy impostors then undergo the medical examination and blood or saliva testing.
In many cases, the insurance agent who issues the policy is a party to the scheme. The
agent or one applicant may even submit the same application to many insurance companies. The
policies are then purchased by viatical settlement companies, which in turn sell them to unsus-
pecting third-party investors. The insurance industry is the biggest victim of this fraud and could
incur huge losses (conservatively estimated at $1 billion+) within the next few years. However,
some investors receive nothing in return for their "guaranteed" investment.
It may seem "morbid" for someone to choose this type of investment; however, viatical in-
vestments are legal and can result in high rates of return.
57
RULE: FULLY UNDERSTAND THE HAZARDS OF VIATICAL FRAUD AND KNOW
WHO THE ORIGINAL INSURED WAS AND HIS HEALTH CONDITION. IF THIS IS
NOT POSSIBLE, TO KEEP OUT OF TROUBLE, EITHER GET A GOOD ATTORNEY
WHO CAN GUIDE YOU THROUGH THE WILDERNESS OF VIATICALS, OR
FORGET THEM.
INVESTMENT FRAUD THROUGH VIATICAL SETTLEMENT
If the siren call of Viatical sales still arouses the instinct to market such a plan, then one
must be, at least, aware of the dangers of fraud so that they can then make an intelligent decision
as to whether they want to sell them, or not.
Historically, some insurance companies have offered an accelerated death benefits option
which allows the insured an opportunity to receive up to 80% of the death benefit at any time
within the last year of their projected life. The remaining 20% is then paid to the insured's estate.
On the other hand, the business of viatical settlements involves the selling of a policy death
benefit, at less than face value, by a terminally ill person to a third party. This, by itself, lends
itself to the possibilities of things "not being on the up-and-up." This transaction is accom-
plished, for a commission, with the assistance of a broker who offers the policies to settlement
provider companies for bid, with the highest bidder obtaining the policy for resale to investors.
The broker receives a commission based on the sale price.
BIG BUSINESS!
The dollar amount of viaticated policies has skyrocketed in recent years. In 1990, approx-
imately $80 million worth of life insurance was viaticated as compared to an estimated $1 billion
in 1999, and estimates indicate that it has grown to close to $2 billion..
Fraud in the unregulated viatical settlement industry has become rampant; and experts in this
field who have watched this growth with dismay, say that as much as 40-50% of the life insur-
ance policies viaticated may have been procured by fraud. Experts estimate that investors have
lost more than $400 million in these types of investments since the industry started in the 1980's.
One corporation alone, charged with 155 felony counts relating to criminal fraud had bad poli-
cies with a face value of $12.7 million.
CLEAN SHEETING
Dishonest persons who haunt the viatical industry procure policies by a practice referred to
as "clean sheeting." This rather interesting term applies to the act of applying for life insurance
while intentionally failing to disclose the applicant's status as being terminally ill. For an agent
who often complains about his company's strict medical underwriting, this is difficult to under-
stand. Basically many, if not most, insurance companies do not investigate the applicant or re-
quire any kind of medical documentation for certain smaller amounts, this way they avoid the
underwriting costs .
58
Many insurance agents and brokers assist and often encourage viators in committing the
fraud because it not only provides more policies than would be available though legitimate
means—as the whole world knows by now, life insurance agents are paid "astronomical" first
year commissions—but it also provides a much higher rate of return due to the fact they can be
bought from viators so cheaply.
In a legitimate transaction, the ill person usually receives 50%-70% of the face value of the
policy. However, a "clean sheeted" policy viaticated during the contestable period may offer as
little as 10% of the face value because it carries the high risk of rescission, or cancellation by the
insurance company, due to fraud.
WET INK POLICIES
After the policy is issued, the insured person will sell his policy—or in some cases with big-
time operators, multiple policies from different insurance companies—sometimes within weeks,
to a settlement provider using a broker. This is referred to as a "wet ink policy" because the ink
on the contract is still "wet" when the policy is sold.
The odds against an individual finding out that he is terminally ill within weeks of buying a
policy are exceedingly high. But when that happens over and over within a short period of time
with the same broker or provider is a pretty strong clue that these policies have been "clean
sheeted."
As is well known to life insurance agent, the policyholder can change beneficiaries whenev-
er he wishes. Therefore, in order to hide the fact that the policy has been viaticated shortly after
issuance, these con artists will obscure viatication by simply changing the beneficiary to some-
one at the settlement provider firm. Or they may just obtain a "collateral assignment" which is
designed to facilitate an insured seeking a loan from a third party and using the death benefits of
the policy as collateral. Of course, in these transactions, they pledge the death benefits but do
not receive a loan.
INCONTESTABILITY PERIOD
Some settlement providers just delay reporting that the policy has been viaticated until the
end of the incontestability period when they can no longer be prosecuted for fraud. While the
incontestability period provides that the insurer cannot question a claim after the policy has been
in force for two years, actually a claim at that time would be based upon fraud, but even though
the insurer cannot withhold payment, the agent/viatical company has acted unethically and their
every move will be watched closely by the authorities.
Still, there is a natural feeling that if the insurance company does not become aware of the
fraud relatively soon after issue, they will "forget" the policy at claims time. A hallmark of these
fraudulent agents is that they nearly always hide the viatication of fraudulently obtained policies
from the insurance company for as long as they possibly can.
The incontestability clause for life insurance lasts for two years after issuance, during which
time it may be rescinded by the insurer for fraud in the application. After this period ends, the
insurer is obligated to pay the death benefit, regardless of any fraud in the application. Because
policies viaticated during the incontestability period may be rescinded, they bring, as mentioned,
a much lower price in the market.
59
THE PITCH
A "pitch" to invest in viaticals would nearly always include the statement that your invest-
ment would produce a 100% return on your investments because you are assigned a specific pol-
icy with a face value of twice your investment and you can claim the face value-death benefit
when the insured on the policy dies.
As an investor, you will have the option of reselling the policy once it becomes incontesta-
ble (two years after the date of the policy) for 70% of its face value.
If, for some reason, the policy is contested or canceled by the insurer, the promoters will
provide you with a replacement policy through a "replacement policy trust" —which, coinciden-
tally, is managed entirely by the promoters.
They represent viaticals as a better investment than stocks, mutual funds, annuities or CD's
for a variety of reasons. To start, you will have full liquidity at the maturity of the policy from
an "A" rated insurance company (?), and the transaction is tax advantaged and is entirely uncom-
plicated. You will receive the100% fixed rate of return which is fully secured by the policy.
There is no risk to principal as this is completely safe, and to top it off, there are no loads or fees
involved. If you get uncomfortable for any reason, or you need your money back, there are short
holding periods with early buyout options. This whole thing is risk free, at no interest rate and
there is no way to lose.
In addition they say you will be making a "humanitarian investment" because the terminally
ill person will be able to use the funds to receive improved health care; pay off debts; take a va-
cation, reduce family stress, and enhance their quality of life. An experienced agent can bring
tears to the most stoic as he describes the squalor in which the insured has been forced to live
because of paying so many medical bills, etc. Oh years, on top of all this, you receive a Mem-
bership Certificate certifying that you are a member of Viatical Funding LLC.
After deducting the fees paid to sales agents, viator agents, and other intermediaries from
your funds, you find that the ill person will actually be left with very little. If the investment is
$45,000 for a policy with a face value of $90,000, the insured who so desperately needs financial
assistance would receive, on the average, only $5,400, which is only 12% of your investment of
$45,000, or 6% of the policy's face value of $90,000. Most investors just look at the fact that
they can double their money—or receive a large amount— and they don't worry about what the
insured receives.
On the fraudulent viaticals, it is not disclosed to the investor that the insured was terminally
ill prior to being insured, such fact was not shown on the application and, therefore, the policy
may be cancelled by the insurer during the incontestable period.
Instead of being designated as the sole beneficiary, the investor may discover that they share
the policy benefits with creditors and family members. Further, the option to resell the owner-
ship interests is not a guaranteed option, but just an assurance that they will "make an effort" to
help you resell the policy. Regardless, it is not likely that the investor will receive the promised
70% or so of the face value, but only the amount another investor would be willing to pay.
And for some reason, they just "forgot" to mention that the risk of the insured living much
longer reduces the annual yield—and miracle drugs are invented all the time. It also slipped
their minds to mention that there is always the chance that the policy might lapse, or that the in-
vestor may have to pay the premiums on the policy for as long as the policyholder lives. They
60
also neglect to mention that they are paid a commission, usually somewhere around 15% of the
investment. And do they ever say who is eventually responsible for monitoring the health status
and location of the insured and when he passes, to get a copy of the death certificate and making
a claim to the insurer?
LIFE EXPECTANCY STATISTICS
Viatical agents will supply investors with statistics that are intended to show the rate of re-
turn on the investment as based upon the life expectancy of the insured. A legitimate viatical
firm will produce actuarial life expectancy reports. However, the con artists may use statistics
that they develop themselves, of have some other person put down a bunch of numbers. There
have been reports of statistics being furnished by a nurse and a plastic surgeon…
Incidentally, Viatical settlements are illegal under Canadian insurance legislation, so Cana-
dians are not allowed to participate in such financial windfalls.
REPORTED SCAMS
Financial Federated Title & Trust, and Asset Security Corporation pled guilty after being
charged with conspiring to recruit insurance agents to defraud more than 3,000 investors while
purchasing viaticated insurance policy investments over a three year period.
Another company, it was reported on the internet, American Benefits Services, was ordered
to pay $129 million restitution on a corporate guilty plea in this case where the three companies
fleeced people with promises of high returns on purchases of life insurance policies from the
terminally ill.
Investors were told that their money would be used to purchase a beneficial interest in viati-
cated insurance policies, and that medical overviews were being performed on the insured per-
sons whose policies were being bought.
Although at least $115 million in investor monies was taken in, the promoters used only $6
million of these funds to buy insurance policies with a total face value just over $7 million. They
used the balance of the money for purposes totally unrelated to the purchase of viaticated insur-
ance policies, such as the purchase of twenty-five houses in Florida, Vermont, South Carolina,
Massachusetts, Georgia, and Toronto, two helicopters, thirty-four luxury automobiles, three mo-
torcycles, several jet skis and boats and a Fort Lauderdale burrito shop.
"PERSONAL CHOICE OPPORTUNITIES"
A variant of this scheme, Personal Choice Opportunities, mislead investors when they
sold viatical securities in the form of loan transactions. This is a little different situation as the
investors are investing in an organization that purchases life insurance policy benefits from ter-
minally ill persons. For loaning money to this firm, they would receive a return on their invest-
ment of 21-25% per annum.
The funds, however, were not used to purchase life insurance policies but those who owned
the company simply kept the money. Over 1100 investors nationwide are believed to have in-
vested $80-100 million in these transactions in just ten months. There has never been any credi-
ble evidence that this company has ever purchased any valid life insurance policies.
61
WHAT THIS DOES TO THE LIFE INSURANCE INDUSTRY
Life insurance premiums are based on actuarial tables using the very latest available data to
determine the longevity of the policyholders, such statistics are obviously worthless in fraudulent
applications. As it is often said, "Insurance Companies are not eleemosynary Institutions." They
have responsibility to their shareholders and their policyholders. Fraudulent viatical schemes
crate additional costs which must eventually be passed on to other policyholders.
This is not intended to say that the viatical industry are all "crooks" —to the contrary in a lot
of cases they serve a necessary function. If, for instance, a young person is diagnosed with AIDS
or some other lethal disease and he is the insured on his own life insurance policy that has been
in force for some time, why, then, could he not sell the policy—it is a personal asset, after all—
and receive a percent of the ultimate face amount that he can put to good use for medical and
other care?
It is fair to say that when this industry started, it was initially the recipient of intensive inves-
tigations and regulations—as, obviously, it should have been. However, they have not done well
in policing itself, and if the industry does not take drastic steps to rid itself of this disease of scam
artists feeding on the ill and dying insured, then the industry will either be so strictly regulated
that it would be difficult for anyone to make any money, or, the industry may be legislated out of
existence.
For an agent contemplating selling viaticals or becoming involved in these transactions, he
must be very aware that because of the fraud so prevalent in the industry that they would work
under a microscope and they could invest a lot of time and energy into a business that may not
exist in a few months from now.
Currently a person charged with viaticating a fraudulently procured insurance policy worth
$100,000 face value, who stands to gain tens of thousands of dollars, faces the same penalty as a
shoplifter who takes a pack of cigarettes in many places, such as 60 days in jail. More stringent
penalties are needed, but unfortunately, the viatical industry has done a lousy job of self-policing
and has not, as an industry, approached regulators for help at this time.
LIFE SETTLEMENTS
Actually, medical advances has created a new target for those involved in viaticals as those
formerly with terminal illnesses may live much longer, therefore the industry has necessarily
started targeting new clients, usually seniors who have life insurance and have considerable cash
value in their policies, and who may be willing to sell their life insurance policies at a discount
so that they can supplement their Social Security or take a vacation that was a lifelong dream, or
help family members financially, etc. These are often called "senior settlements" as most of the
policies that are purchased are on the life of a senior.
The owner of the policy gets cash and the buyer becomes the new owner and/or beneficiary
of the life insurance policy, pays all future premiums and collects the entire death benefit when
the insured dies. Simple. Much in the same line as selling mortgage loans to seniors who can
take their equity out of their house to help them financially in their later years.
62
People decide to sell their life insurance policies for many reasons. Some common ones are
the changed needs of dependents, a desire to reduce or eliminate premiums, and a need for addi-
tional cash to meet expenses.
As a general rule, states have not regulated life settlements as closely as they have viaticals.
Certain aspects of these transactions may fall under the various Securities Acts so there can be
financial risks involved when entering into such arrangements.
The seller/insured should be advised to contact a professional tax advisor to find out the tax
implications as life settlement proceeds are generally not tax free. They should also know as a
seller, that they will be required to provide certain medical and personal information to third par-
ties who will be paid the proceeds from your policy upon your death. These third parties may
sell your policy and pass along your medical and personal information to other individuals.
Typically, life settlements are offered to buyers, for resale to investors, at a discount from
the death benefit. The discount is for the entire life of the policy, not an annual rate of return as
an annual rate of return cannot be guaranteed. The rate of return depends, obviously, on when
the insured dies, at which time the investor will receive the settlement. This is not, and could not
even be considered to be, a liquid investment as no money is available until the insured dies.
RECENT LEGAL ACTIONS AGAINST VIATICAL COMPANIES
VESPERS
The Alabama Securities Commission issued a Cease and Desist Order against Viatical &
Elderly Settlement Providers, LLC (VESPERS) Washington, D.C., to stop conducting busi-
ness in the state of Alabama after they received information that they were engaged in the illegal
offer and sale of investment contracts involving fractionalized viatical settlement contracts
there.
VESPERS, though not licensed to sell this type of security in the state, have solicited inde-
pendent insurance agents to sell interests in viaticals issued by them with promises of low risk
and high returns of 28-70 percent on two to five year investments for a 10% commission.
MUTUAL BENEFITS
(From a published report and reiterated on the Internet)
05/01 – "Dr. Clark Carlton Mitchell, 43, a Miami Beach doctor working for Fort Lauder-
dale-based Mutual Benefits Corporation, one of the country's largest viatical settlement pro-
viders, has been charged with 25 counts of organized scheme to defraud and communications
fraud for allegedly lying about conferring with the personal physicians of terminally ill policy-
holders before assessing their life expectancies. If convicted, he faces up to 150 years in prison
and as much as a $130,000 fine.
Estimation of life expectancy is key in an investor's rate of return in a viatical investment
and an improper calculation can be devastating to an investor. As a result, two dozen elderly in-
vestors may have been misled in their decisions to invest a total of $350,000.Many of the inves-
tors purchased the viatical settlements as part of a retirement plan.
63
Mutual Benefits was linked to the arrests a year ago of eight men on charges of submitting
false information on eleven life insurance applications to get more than $1.1 million worth of
coverage from various insurers.
The eight were then linked by investigators to the purchase of a total of 47 policies worth
$4.9 million from 32 different insurance companies, which were then sold to viatical settlement
providers, primarily Mutual Benefits, for more than $700,000.
Investigators said these policies first were "warehoused" with brokers and then marketed by
Mutual Benefits to investors after the two-year "contestability period" had lapsed. These provid-
er-companies then marketed the fraudulently obtained policies to unsuspecting investors.
Seven of the suspects are charged with one count of grand theft and one count of dealing in
stolen property. They're identified as Ralph Cahall and Richard Fraher Jr., Anthony Marano, Guy
Leopold, Albert Esposito Jr., Joel Seidman, and Edward Hoseclaw. The eighth was charged with
an organized scheme to defraud and four counts of grand theft.
Mutual Benefits lost a court challenge to prevent the insurance department from examining
its records where a preliminary review by the department indicated "obvious fraud" in life insur-
ance applications on file with the company.
In Florida, there are eight viatical provider companies and about 90 brokers licensed to buy
life insurance from policyholders for resale to investors, who then become the beneficiaries.
To date, the insurance department has executed seven search warrants and seized more than
1,000 viatical settlement files, representing more than $76 million worth of life insurance poli-
cies that investigators suspect were fraudulently obtained.
Anyone with information about this case or any possible viatical fraud scheme in Florida
should call the Department of Insurance Fraud Hotline at 1-800-378-0445. A reward of up to
$25,000 is offered for information leading to a conviction."
OTHER VIATICAL COMPANIES
02/00 - Several companies and individuals who helped market to investors about $9 million
worth of life policies that had been "clean sheeted" or obtained by hiding an insured's terminal
illness from 53 life insurers were charged collectively with 240 counts of grand theft, organized
fraud and dealing in stolen property.
Future First Financial Group Inc., a viatical settlement provider, and Future First's vice
president, William F. Sweeney, 51, each were charged in one indictment with 81 counts of
grand theft and one count of organized fraud in connection with the marketing of fraudulently
obtained policies valued at $6.9 million.
Wanda Tappan, 56, the president of Life Benefit Services Inc., a viatical settlement broker;
Bruna Coveleski, 54, the company's vice president; Stan Coveleski, 55, the company's chief
financial officer; and, Joel Seidman, 44, a client representative, each were charged in a second
indictment with one count of organized fraud, and a total of 72 counts of dealing in stolen prop-
erty in connection with the sale of about $2.5 million in fraudulently obtained policies.
Last October, the officers of Justus Viatical Group, were indicted on numerous charges of or-
ganized fraud, grand theft and insurance fraud relating to some $3 million in fraudulently ob-
tained policies which were bought by the company's two officers, and then resold to investors for
64
some $2 million.
Future First in some cases paid the insured only 12% of the face value for policies it bought. For
helping arrange the sale of just one policy for $122,746, Life Benefits was paid a $48,510 com-
mission.
Suit seeks to recover losses from insurance scam - 1,000 Ohio investors lose; money
laundering, fraud charges are filed
03/19/04 - AP- DAYTON - Victims of an alleged $20 million swindle hope they can recoup
some of their losses as a court-appointed receiver tries to straighten out the mess.
``That was my life savings,'' Barbara McAdory, 61, of suburban Trotwood, said of the
$72,000 she invested in policies sold by LifeTime Capital Inc. of nearby Miamisburg.
``Everything's down the drain now,'' she said.
The LifeTime founder and seven others have been indicted in Pensacola, Fla., on fraud and
money laundering charges.
Brad Stockslager, 28, who came to the Dayton area to help his 93-year-old grandmother,
said he found that $499,000 of her savings had been invested in portions of 12 life insurance pol-
icies. He said his grandmother must spend $3,000 a month for assisted care, not including medi-
cal expenses, and receives only about $1,800 a month.
H. Thomas Moran of Oklahoma City has been appointed receiver in connection with a law-
suit filed in U.S. District Court in Dayton by H. Thayne Davis of Edmond, Okla., who is seeking
to recover $613,000 invested in policies held by LifeTime. Moran is seeking to recover money
on behalf of an estimated 4,000 investors, about one-fourth in Ohio.
Among Moran's efforts, he said, will be seeking restitution on behalf of investors in the
prosecutions in Florida and tracking assets of those accused of defrauding them. He plans to fo-
cus on the $157 million LifeTime portfolio.
Investing in life insurance policies of those near death emerged primarily as a result of the
AIDS epidemic. Terminally ill people sold their life insurance policies to companies such as
LifeTime Capital for a percentage of the face value, a deal called a viatical settlement.
The dying got cash to use in their final years, while the investors who buy the policies were
told they could receive returns exceeding 60 percent if the dying -- called viators -- died within
their projected life expectancies.
The lawsuit said most haven't died because an alleged ``sham'' company provided false life
expectancies of viators.
Gerald Myers of Dayton, a certified public accountant, said he has six clients who bought
LifeTime policies, including a couple in their late 70s who have their remaining life savings of
$800,000 tied up in the policies.
``He has since gotten Alzheimer's and is in a nursing home under Medicaid,'' a program for
the indigent, Myers said.
Miriam Gates, 64, of Dayton said the $18,000 she and her husband, Rufus, 68, invested in
the policies ``was the only thing we had. It was like a cushion -- we knew it was there to draw on
in hard times.''
65
Big Name Lawyer Involved in Lawsuit Against Viatical Scammer
LOS ANGELES - 08/06 - (AP) A high-profile celebrity attorney has settled a lawsuit accus-
ing him of siphoning money from a $90 million death futures scam that one of his clients ran.
Attorney Robert L. Shapiro, who has represented O.J. Simpson, Christian Brando and other
celebrity clients, reached the settlement Tuesday with attorney Barry A. Fisher, who was as-
signed to recoup the investors' losses from the scam.
Terms of the settlement, which was reached as jury selection was about to start in the civil
case, were confidential. Fisher had been seeking at least $3.5 million.
In 1997, Shapiro represented David W. Laing, the owner of Personal Choice Opportunities
Inc. in Palm Springs, which purportedly allowed the terminally ill to sell their insurance policies
at less than face value so they could use the money while they were alive.
Personal Choice promised investors in the company 25 percent returns, but authorities said
the insurance policies never existed.
Laing pleaded guilty to conspiracy to commit securities and mail fraud and served eight
years in federal prison before his release a few months ago.
Fisher, who was appointed by the court to reclaim the investors' money, filed suit in 2001
accusing Shapiro of arranging for up to 12 bags, each filled with $500,000, to be taken from
Laing's home in April 1997 so the defendant could post bail.
Fisher claimed in the lawsuit that Shapiro also took at least $200,000 of that money for at-
torney fees - although he should have known that the money was "illegally and fraudulently ob-
tained."
Shapiro denied any wrongdoing, saying he had acquired the money from the sale of Laing's
home and that his payment had been approved by a federal judge.
Fisher said outside court he has recovered much of the $90 million for investors, but about
$15 million remains unaccounted for.
RULE: ENTER THE VIATICAL MARKET AT YOUR OWN RISK!
STUDY QUESTIONS
1. Not only have annuity interest rates become competitive with other investment products, but
A. at the present time a fixed annuity beats any other investment product.
B. annuities also enjoy deferral of income taxation on earnings.
C. annuities also enjoy the elimination of income taxation on earnings.
D. Variable Annuities may be marketed only by insurance agents.
2. The Exclusion Ratio
A. applies to all annuities.
B. applies to all annuities except Variable Annuities.
C. only applies to Universal Life products.
D. only applies to indexed products.
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3. Section 1035 of the IRS Code pertains to
A. all income from annuities.
B. exchange of policies without taxation.
C. the taxation of all insurance policy exchanges.
D. IRS penalty for early withdrawal of the funds of an annuity.
4. No matter what kind of annuity is purchased, it may be subject to a 10% IRS penalty
A. for withdrawal of income prior to age 59 ½.
B, when the building up of the cash value or investment part exceeds 105% of the premium
paid in.
C. if it is being substituted or exchanged for a like annuity.
D. on the initial investment for the first year.
5. One of the problems in the past with viatical sales is
A. often the insurance agent who issues to the policy is a party to the scheme.
B. that it is unprofitable and no legitimate company offers it any longer.
C. that the agent must hold a securities license.
D. the market only attracts those with HIV-AIDS.
6. When a life insurance policy applied for and there is intentional failure to disclose the appli-
cant's status as being terminally ill, this is called
A. wet ink policies.
B. Section 1035 underwriting.
C. an ERISA plan.
D. clean sheeting.
7. Fraudulent viatical schemes affect the "legitimate" life insurance business
A. to such a miniscule extent that rarely is there any legal action taken against them.
B. as they put the agent in such a high income bracket that the legitimate agent may stop
writing insurance and just sell viaticals.
C. because they actually show how much better an insurance policy is for investment
purposes so more life insurance is marketed.
D. as insurers have to make up for their losses due to these schemes, which drives up the
cost of insurance to legitimate policyowners.
8. The insurance industry has counterattacked viaticals to some degree by
A. firing any agent that has ever sold viaticals.
B. offering life settlements which allows seniors to sell their policies at a discount.
C. hiring their own investigative staff to investigate every viatical plan.
D. just ignoring the problem and hopes it goes away.
ANSWERS TO STUDY QUESTIONS
1B 2B 3B 4A 5A 6D 7D 8B
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CHAPTER FIVE - DISABILITY INSURANCE ETHICS
IT'S NOT MY PLACE TO STEER THE SHIP,
OR EVEN RING THE BELL.
BUT LET THE DARN THING START TO SINK,
AND SEE WHO CATCHES H —!
Any insurance agent "worth his salt," is well aware that the insurance agent is, as far as the
insured is concerned, "the insurance company." Agents have a tendency to forget that they, and
they alone in many cases, are the only reference to the promises made by the agent and the insur-
ance company. So if something goes wrong, the agent is usually the first to know and when the
insured has a claim, whether they like it or not—the agent may be right in the middle. If the
claims department does not fulfill its obligations, or even the obligations that the insured feels
should be honored, then the wrath will usually be pointed toward the agent. After all, the agent
"made the promises" and attempts to "push the blame to an adjuster or claims manager" tend not
to satisfy the irate client.
Therefore, a professional agent will always make sure, in their own mind and regardless of
any representation as to how superior the insurer is during times of claim, just how the insurance
company fulfills its obligations. Keep in mind that an insurance company can abide by all the
insurance laws and regulations and still exercise bad faith in the settlement of claims. The ques-
tion then becomes—how does the insurance agent know how claims are being handled?
There is no easy answer to that question other than the obvious (but usually ignored) act of
contacting the Department of Insurance and inquiring as to whether they are any problems re-
ported in respect to claims practices. The Department can certainly tell you if there are financial
problems of which they are aware, and if there are, they often will not discuss details, but will
give an indication that perhaps all is not what it seems.
Run the company through Lexis-Nexis or some other database and see if it has received bad
publicity in respect to paying claims. Newspaper records can help in this respect. Some agents
keep their "ear to the ground" and if an agent leaves an insurer, they are quick to ask "why."
There can be a lot of logical and legitimate reasons for an agent to leave an insurer, but once in a
while an agent will report that they were fed up with lousy claims practices and they were tired
of catching flack from clients.
What if the agent takes the position that it does not make any difference how claims are han-
dled as that is the job of the insurance company and not the agent. This approach is also known
as the "ostrich" approach (for apparent reasons). If an agent closes his eyes to claims of bad faith
in respect to claims handling, this is an unethical approach as they are not ethically representing
their clients.
A discussion of a situation where an otherwise reputable and reportedly financially strong in-
surance company was convicted (soundly) of insurance fraud because they did not pay the claims
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that they were obligated to pay, may shed some light on how these insurers operate. The good
news is that very, very few insurers are so unethical.
The following is more-or-less a case study of an insurance company that violated a plethora
of ethical (and many legal) rules.
THE BACKGROUND OF DISABILITY INSURERS
Disability insurance is a rather common type of health insurance which arose from union
member requirements in the 19th century that they no longer be treated as commodities, and since
they spend most of their lives working hard at their chosen occupations, they wanted peace of
mind. Thus, disability insurance which provides that if the insured can no longer work because
of an injury or illness, then the insurer will pay.
Insurers loved this plan as all they had to do was to come up with a competitive benefits
package, price premiums aggressively, pay high commissions to insurance agents, and watch the
coffers fill. These plans were actually started in the 1980's, when interest rates were high –
double-digit in fact, and in case one is not aware of this:
Insurance companies rarely make any money on premiums—they make their
real money on investments.
By 1983 there were dozens of disability insurers active, but only three major companies who,
either through loose lips or business espionage, had nearly identical plans. The plans that they
sold were basically "own occupation" policies. For the uninitiated, this means that benefits
would be paid if they were unable to perform the duties of his/her "own occupation. Said poli-
cies were noncancellable, and generally, premiums could not be raised. Benefits were paid any-
where from age 65 to lifetime, along with various bells-and-whistles (such as cost-of-living ad-
justments).
Selling it was comparatively easy—every company played on fear. People (especially those
in professional positions, (doctors, architects, lawyers, etc.) were warned that they must be pro-
tected against a situation where they could not perform their specific occupation. And they
bought it and bought it and bought it.
Then came doomsday in the form of interest rates plunging to unexpected low levels. This
meant that since the insurers made most of their money on interest on their investments, and
since they were not receiving but a portion of profits that they had anticipated, therefore their
claims ratio (the ratio of claims to income) climbed sky-high. The claims/investment profits
formula dropped profits like a rock. Keep in mind that these figures were what had been used by
the actuaries to determine the premiums that continued to be paid on the policy—and the policies
were noncancellable!
In 1993 one company, in particular, took a loss of almost a half billion dollars that was
caused by having to increase the company's reserves so that they were in the proper financial
condition to pay their existing and projected claims. And what was even worse as far as the in-
surers were concerned, was the fact that if interest rates continued to stay low (which they did)
losses would continue to grow, having a negative effect on profits—and, by extension, stock
prices.
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Changes had to be made, obviously, and the largest of the insurers in this field took the first
step by appointing a new CEO, a well-educated banker who knew the worth of a dollar (but
knew very little about insurance, it seems). He found a seemingly unsolvable dilemma. The
company could do absolutely nothing about the low interest rates, but on the other hand, it con-
tinued to receive more and more and more long-term claims every day. (Short-term claims were
not of concern, as they were payable and were of smaller amounts.)
What it seems the company (and the new CEO) forgot—or never knew—was that
An insurance company must operate on the implied promise of good faith
and fair dealing and the financial interest of the company must never be put above those of
its policyholders.
An insurer must never conceal benefits, unreasonably delay the payment of claims or the
termination of a claim and it must never reject a valid claim. Investigations must be full, fair and
objective. The insurer must never conceal benefits (a fact of life: assume that nobody ever reads
the policy as a miniscule amount of insureds actually do—and of those that do read the policy,
another miniscule amount of them understand it). The company must always pay up honestly on
legitimate claims.
One of the three largest writers of this insurance acquired through merger and/or acquisition,
the other two. Therefore, the major determination, it seemed to the insurance company, in de-
termining exactly what is "legitimate" and what is not, is the responsibility of the insurance com-
pany. And, if the claimant disagreed, the claimant always had the right to sue the multi-billion
dollar company with a regiment of in-house lawyers plus brigades of high-priced outside legal
counsels.
Still, having many lawyers is not a crime or even a "sin," as the insurance company is en-
trusted with the money of its policyholders so they are expected (and required) to have not only
adequate legal counsel, but also outstanding legal counsels. What is a "crime," or is, to say the
least, unethical is to fraudulently deny legitimate claims. How this was done makes the kind of
story that appears on "Sixty Minutes" and in newspapers, new programs and books—and it did.
This information was gleaned from various sources, but the name of the insurer and other partic-
ipants is beyond the intent or scope of this text. In this case, "names are not provided so as to
protect the guilty."
HOW CLAIMS WERE AVOIDED
According to testimony in the trial, and verified by the courts, this company set up "roundta-
ble' discussion groups whose purpose was to determine the percentage of claims that were to be
denied so that the company could meet their profit expectations. It did not matter a whit if the
claim was legitimate or not, whether the claimant was particularly needy, or any other reason to
pay the claim—the claimant was just a statistic that needed to be "gotten rid of" so as not to af-
fect the bottom line. And there were several severe cases, some represented by the same law
firm, such as a doctor that was diagnosed with cancer but he attempted to continue working as
long as he could, eventually succumbing to cancer before the case was settled in court and leav-
ing a destitute widow and several children. Another case was a chiropractor whose health dete-
70
riorated and who even offered work with the insurer to get into another field but the company
refused to pay for training—plainly offered in the policy.
Some claimants were covered by one of the three large insurers before they merged, and in
some cases, the insurer was paying claims but when they merged, the new company cancelled
payment of benefits. When the cancellation of benefits was questioned, the company hired doc-
tors who specialized in reviewing disability benefits and resolving them in favor of the company.
(Yes, indeed, there are those that find such practice more lucrative than taking care of the sick
and needy.)
OVERSIGHT REGULATION
One may wonder how in the world such shenanigans can happen. Forgetting about State
regulations for a moment, many wonder why the federal government does not step in. Well, be-
lieve it or not, they do and when they do they do nothing for the policyholder. The only federal
regulation requires a very short discussion; otherwise there is no federal regulation as there are
no federal insurance regulations. And, since many people feel that federal intrusion into the in-
surance business would just wind up protecting insurance companies instead of safeguarding po-
licyholders.
States have "unfair insurance practices acts," known by various but similar names throughout
the country. These laws make it illegal for insurance companies to:
Engage in unreasonable delay
Underpay, terminate or deny valid claims
Place their own financial interests ahead of their policyholders
Conceal benefits from claimants
Interpret policy ambiguities against insureds (this is enforced strictly)
Use their financial means or size to intimidate claimants or force the claimants to set-
tle claims for amounts less that provided for under the policy
Force policyholders to sue them in order to obtain benefits that are due.
In addition, states have various other regulations involving the enforcement of these provi-
sions and other state insurance provisions.
So, what is the problem? — you may ask. The problem is that there is no insurance depart-
ment in the entire country that has the authority to sue an insurer on behalf of a cheated claimant.
All they can do is to investigate to see if the insurer is violating unfair practices law and it a rare
situation where a company is fined for such violation.
Some states (in particular California) do actually have some good protection for policyhold-
ers. But even in these states, including California, these rights are taken from them by a creature
of federal legislation called ERISA (Employee Retirement Income Security Act of 1974).
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ERISA PREEMPTION
ERISA was originally intended to protect the retirement benefits of employees against mer-
gers, acquisitions, and other such situations and activities that may endanger the retirement funds
otherwise. Interestingly, originally ERISA had nothing to do with overriding state insurance
regulations and it specifically approved state laws to regulate insurance.
However, enter the well-intentioned US Supreme Court which in 1987 "tore everything up,"
as a result of the intention to encourage the formation of employee benefit plans. What hap-
pened in this Chinese fire drill was that insurance companies were afraid that their customers
could sue them. Horrors. So they approached the Supreme Court and asked for their help. If the
Supreme Court would take away the rights of policyholders to sue them under state laws (or
more specifically, insurance purchased at the workplace) and if the Court would say that state
law protection is to be preempted by federal law, the insurance companies would be immunized
from fraud–primarily because there are no federal protections anyway. And if the Supreme
Court did this, the insurers could lower premiums in the workplace policies and the insurers
could lower the premiums and the insurance would be affordable so more people would buy it
and the world will be a better place…♫
Of course, there were those who opposed such a blatant attempt of the insurers to escape re-
sponsibility for their acts, saying that they were allowing insurance companies to cheat their own
policyowners. Besides, even if the costs were lower, there was no guarantee that the insurers
would lower their premiums by any amount. They also made the argument that people can lose
their homes as there is no federal regulation, ergo, no federal deterrent.
The Supreme Court effectively thumbed their nose at these arguments and they ruled that
henceforth, ERISA shall be the law of the land and will eliminate all state insurance protection
on policies purchased at work as all consumer rights under state laws are preempted by ERISA.
Hard to believe in retrospect, but even to this day, policyholders have no rights to recover for
losses caused by such practices, and a targeted policyholder has no leverage, no right, and no
strength to get his insurer what is due him under its policy. So what does this actually do, one
may rightfully ask? Some insurers simply do not pay claims.
If this is hard to believe, there was a highly confidential memorandum admitted to court from
the largest long-term disability writer that stated"
"A task force has recently been established to promote the identification of policies covered
by ERISA and to initiate active measures to get new and existing policies covered by ERISA.
The advantages of ERISA coverage in litigious situations are enormous: state law is preempted
by federal law, there are no jury trials, there are no compensatory or punitive damages, relief is
usually a limited to the amount of benefit in question, and claims administrators may receive a
deferential standard of review. The economic impact on [the insurance company] from having
policies covered by ERISA could be significant. As an example, [a company officer] identified
12 claim situations where we settled for $7.8 million in the aggregate. If these 12 cases had been
covered by ERISA, our liability would have been between zero and 5.5 million." (From an in-
ternal memorandum, labeled "PRIVILEGED" to an internal management group, on October 2,
1996. Presented in the Court as Exhibit 225.)
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Can you see what will happen and what has happened, and probably is still happening today?
To deny a claim an insurer could first identify the policy as an ERISA policy, therefore effective-
ly eliminating this claim as the policyholder now cannot sue and insurer. Of course, if the clai-
mant has a smart attorney, they can have the court determine whether the policy was, in fact, an
ERISA policy. Courts have generally bent over backwards to protect the policyholder.
Don't even ask how come an ERISA preemption can even exist, since it is inconsistent with
the McCarran-Ferguson Act that barred the federal government from regulating insurance. One
should not ask as there really is no logical answer.
In this one particular trial, the claimant was asked at court if the insurer ever told her that her
claim was preempted by ERISA. The insurer's attorney objected loudly and vociferously about
the question, but it was ruled proper. The claimant testified that she had been told that it was an
ERISA case. Fortunately, she did not do like so many would have done—walk away with noth-
ing under the impression there was nothing she could do.
ERISA UNLICENSED INSURANCE COMPANIES
One other thing about ERISA that those in the health insurance business know well. There
are health insurance companies who cannot become licensed in your state, usually because they
do not have sufficient capital and surplus, or their reserves are inadequate, or for some other rea-
son. But they want to sell health insurance in the state nonetheless, so they enter as an ERISA
company. For years small insurers sneaked into various states and wrote business, but in recent
years the Insurance Departments have become more vigilant and in some cases have taken the
insurance license away from those who represent these "ERISA" companies. These companies
invariably offer lower premiums than those offered by other companies, but more importantly,
they accept medical risks that other insurers decline or do not accept at the usual premium.
As an example, the Florida Department of Insurance issued a statement to the press and to
agents in the state, in respect to these companies:
FL orders unlicensed health insurer to stop selling policies
By Vicki Lankarge (insure.com )
Florida Treasurer and Insurance Commissioner Tom Gallagher has ordered N.A.P.T. — a
Pennsylvania-based association with more than a dozen "identities" — to stop selling health
insurance in Florida because it is not licensed to do business in the state. Regulators say they
believe "tens of thousands" of Florida residents may have purchased policies with N.A.P.T.
or its affiliated organizations. Gallagher has also demanded that N.A.P.T. immediately turn
over its claims-handling process to a licensed third-party administrator.
The association primarily sells policies under the initials N.A.P.T. but it has also sold insur-
ance under numerous other names, including the National Association of Professionals &
Technicians and the National Association of Professional Truckers, according to Tami
Torres, a spokesperson for the Florida Department of Insurance. Torres says department
regulators believe that these associations have been selling unauthorized health insurance
policies since 1999 to the self-employed and employers that range from small groups all the
way up to large groups with more than 100 employees.
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None of the affiliated associations or the plan administrator, David Weinstein, has ever been
licensed as an insurer in Florida, according to Torres. In addition, Torres says the depart-
ment does not currently know how many policyholders have purchased the illegal policies
in Florida because N.A.P.T. is not cooperating with regulators.
"An unlicensed entity like N.A.P.T. is luring in employers with low rates for health insur-
ance coverage, often through slick TV advertising, but what they are really offering is a
false sense of security," Gallagher says. "Unlicensed entities are not regulated, may not be
actuarially sound, and are not required to guarantee payment of claims if their company
goes bankrupt."
PHONY ERISA POLICIES
Florida insurance regulators claim that N.A.P.T. is falsely marketing to insurance agents and
consumers that they are a qualified Employee Retirement Income Security Act (ERISA) plan,
which under federal law is generally exempt from state regulation. An ERISA plan allows an in-
dividual employer to establish and self-fund a health plan (and assume the financial risk) for its
own employees. However, any plan that sells insurance policies to more than one employer
does not meet the federal exemption requirement and must be licensed and regulated by the
state.[emphasis ours] Gallagher issued the final cease and desist order to N.A.P.T. on March 30,
2001. It required the organization to:
Notify current policyholders that they should obtain new coverage.
Turn over its claims-handling processes to a qualified third-party administrator within 15
days.
Continue to pay claims until further order of the Florida Department of Insurance.
According to Torres, N.A.P.T. and Weinstein had five days to request a hearing to appeal
the order. "Under the order, the association remains responsible for honoring the policies it has
issued," says Gallagher. "Nevertheless, I believe it is in the policyholders' best interests to look
for new coverage. This insurer has no license and therefore it has not undergone the regulatory
scrutiny that licensed companies do."
Florida insurance department regulators were made aware of the unlicensed entity through
consumer and insurance agent complaints of policy cancellations for no reason and without
proper notice, as well as slow — and sometimes no — payment of claims. According to Torres,
insurance agents also called to complain that their legitimate business was being siphoned away
from them by N.A.P.T. and its affiliated organizations, which were offering group health insur-
ance policies at extremely low rates.
Although N.A.P.T. and its affiliated associations was not under criminal investigation at this
time, the Florida Department of Insurance has not ruled out filing criminal charges once the ap-
peal period is over.
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HOW TO SPOT ERISA SCAMS
From the viewpoint of an agent who is not familiar with this scam, there are certain warning
signs that can help an unknowing agent from the pitfalls of ERISA scams.
The coverage costs 25% (or more) below the norm, yet the plan promises generous
benefits and a large provider network.
The plan readily accepts people with serious illnesses and other medical conditions
that other plans usually reject.
There are few—if any—underwriting guidelines and the representative of the organi-
zation seems too eager to sign the agent.
The initial approach to the agent is through another insurance agent, or by phone or
direct mail. Legitimate group plans usually are sponsored by the employer and are
not sold directly to individuals.
The plan is not licensed in the state, but the representative assures you that federal
ERISA laws exempt the plan from state licensing (which is not true in nearly all cas-
es).
Watch for terminology when the plan is described. If "insurance" never passes the
lips of the representative, but "benefits" flows like water, then watch out.
The representative does not have clear answers to questions, and seems ill-informed,
or avoids sharing information.
No one has ever heard of that health insurance company.
One must join an "association" or "union" in order to obtain the health coverage. But,
the customer gets no voting rights, receives no by-laws or other material on the or-
ganization, and there is no way to become involved in the group's activities.
There have been instances where a well-meaning agent has notified one of his clients—often
owners of small businesses—of a health insurance plan he has "run across" that seems low in
cost and has great benefits, and suggests that maybe his client might want to look into it.
If the agent really doing his client a favor? If the attitude of the agent is that he will notify
the client that such a plan exists, and everything else is up to the client, there can be BIG trouble
for the agent.
RULE: NEVER RECOMMEND, OR EVEN MENTION CASUALLY, TO A CLIENT
THE AVAILABILITY OF OTHER INSURANCE COVERAGE WITHOUT FIRST
INVESTIGATING THE COVERAGE COMPLETELY.
If an agent just says "This is just a suggestion, I really don't know much about this compa-
ny…" or use some other "blame-eliminating" phrase, then, like it or not, this coverage is not a
suggestion, but since the agent is the "expert" it is automatically now a recommendation. If the
plan is not legitimate, the very least that could happen is the loss of a good client. The worse
thing that could happen is the agent losing his license and being fined.
Remember – there is no "caveat emptor" in the insurance business.
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OTHER ETHICAL PROBLEMS INVOLVING DISABILITY INSURANCE
In one of the more troublesome cases, the head of the insurer's "Customer Care" Center who
had the responsibility to establish the company's claims-handling procedures and philosophy
consistently stated in discovery that it was his practice to employ the "highest ethical standards"
in all aspects of his work.
As an example as to what a plaintiff may face if he sues an insurer, in one case where there
was an internal document admitted as plaintiff's exhibit 34, entitled "Individual Disability Claims
Performance Objectives," the plaintiff's attorney asked, "Is it acceptable in the processing of in-
dividual disability claims to have 'objectives' for how many claims should be terminated?" The
answer was that it was not acceptable, and that the document states that for every new dollar in
claims, the claims department should terminate eighty-four cents worth of existing claims and
the company developed a formula (net terminations ratio) to track this activity and to set goals
for the termination of ongoing claims. (This is SCARY…)
In the same vein, it was stated in court that each claims adjuster was directed to provide a top
ten list of claims that "with intensive effort" could be terminated.
Is this proper? The question was asked of a reputable and well-known insurance expert, who
earlier had stated that "Claims evaluations must be fair and thorough. A company cannot avoid
obtaining, or ignoring, information that supports payment of the claim. It cannot misinterpret or
misrepresent or misstate the policy benefits. It cannot put its own financial interests above those
of the insured. It cannot force a policyholder to sue in order to collect benefits owed." This ex-
pert testified that it would certainly be improper.
The expert also testified that the memos that were presented in court revealed business atti-
tudes and practices that violated even minimum insurance industry requirements and standards.
Also, from the voluminous material presented in court by the plaintiff's attorney, the expert
stated that he had drawn other conclusions—such as using untrained people to deny claims,
people who did not even know the required standards of disability. Further, the company relied
upon a medical examination doctor who gave a biased report (totally demolished by medical ex-
perts in the trial). They also misrepresented the requirements of the residual disability coverage
and told the claimant that she was not qualified for that coverage (actually she was qualified and
had asked the company if they could help her financially so that she could learn another trade).
They concealed her rights under the 36-month rehabilitation coverage (the insurance company
just did not want to pay anything!).
In testimony, it was revealed that the primary manager of the claims department testified in a
deposition that he did not know whether insurance companies were required to handle claims
fairly, didn't know whether they were required to investigate them thoroughly, and did not know
whether their assessment of a claim even had to be objective. This from a man who had been
promoted several times, had the authority to cut off claims, and who was in charge of training
other claims handlers. Really, this happened.
Okay, now that it has been established that the claims adjusters and mangers were incompe-
tent, what did that have to do with the agent? The claimant was asked about what the agent had
told her, and it was quickly apparent that the agent evaded talking about the "important duties of
her occupation" (upon which the insurer was hanging its case). The insured testified that the
agent was very adamant in the beginning that even if the insured did paperwork, it certainly
wasn't her occupation. (The insurer was attempting to say that because the claimant, who was a
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successful chiropractor, was not able to work as a chiropractor any longer; she could still do
"important duties" such as bookkeeping. How she could do that with a now-defunct chiropractic
office, one might rightfully ask?)
The agent had told the claimant that the (claimant) was a chiropractor, and "your important
duties are chiropractic; it doesn‘t matter if you do paper work, it doesn't matter–you are a chiro-
practor; that is why you are getting this policy." Misrepresentation? Oh, yes. Even though she
may not have been aware of the claims policy of the company she represented, she was interpret-
ing a part of the policy wording that she did not understand—and as it eventually was known, no
one in the claims department understood that provision either. The saving grace in this particular
case was that the attorneys for the plaintiff did not want to waste time going after the "small fry"
and it may be hard to prove that the agent was deficient in this respect. It would be difficult to
state that the agent was unethical in this case if she had no knowledge of claims problems and
she had been informed in writing as to what consisted of a definition of "own occupation." Yet
there seemed to be either a misunderstanding or lack information from the agent on policy defi-
nitions. Is an agent's lack of education/information on how the insurer pays its claims, unethical?
DEFINITION OF "TOTAL DISABILITY"
As expected, the definition of "total disability" under the policy also arose as the policy pays
when the policyholder is "totally disabled." Under deposition, one of the expert witnesses stated
that the correct definition of "total disability" was the inability to perform one's duties in the
usual and customary manner and with reasonable continuity." What was interesting was that the
top claims examiner for the insurance company being sued neither knew the correct definition of
"disability" nor did he know that insurance companies were required to handle claims fairly, ob-
jectively, or thoroughly.
In another claim, the claimant had been approved for Social Security Disability payments,
but the insurer denied benefits under its policy. SSI defines "disability" as where the individual
is disabled from performing any disability. No surprise, but this claim was originally declined as
the insurer attempted to convince the claimant that his policy was governed by ERISA rules.
Didn't work, even though the company requested an IME (independent medical examination)
they finally settled for an undisclosed sum.
INTERPRETATION OF THE POLICY
As a general rule, plaintiff's attorneys are on the other side of the fence in many insurance
cases. However, in one disability lawsuit, the plaintiff's attorney put into words exactly what is
expected of an insurer.
"This company should interpret its policy fairly and honestly. It should treat people with de-
cency. It should not willingly destroy people's lives for their own profit. "That's what the im-
plied covenant of good faith and fair dealing is all about. It is why our courts read that promise
into every insurance policy—just as if it were written right there on the front page with a big felt-
tipped pen. Insurance companies have a 'continuing duty' to review all aspects of a claim, to re-
view any "new information" that it might say that it was previously unaware of." (Ray Bourhis,
Insult to Injury," p.157)
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CONCLUSION OF EXAMPLED CASE
It would not be fair to discuss the mishandling and fraud initiated by this insurance company
without discussing what happened to the lawsuit.
The insurer lost the lawsuit and was hit with a large punitive damage award. Of course this
was all appealed, and Dateline had another expose on the company and the way that it treated
another, different, claimant. The appeals judge on Nov. 12, 2002, rendered a "Findings of Fact,
Conclusions of Law and Order" which was characterized by the legal press as a "62 page hand
grenade."
The judge found that the company had targeted claims for termination when they met a cer-
tain profile, that claims were discussed at the "roundtable" where it was determined as to the me-
thods that would terminate the case successfully, and further, the insurer made the insured take a
"biased medical examination."
The judge found that before the relatively new CEO came to the insurer, claims were handled
in a fair and aboveboard way, but after their arrival, standards slid to those that were not ethical
for an insurance company. He acknowledged that the insurer's own witnesses did not know the
proper definition of "disability," had admitted to destroying medical reports from examining doc-
tors, failed to document claims, failed to advise insureds of covered benefits, failed to settle
claims when liability was clear, and forced insured to litigate in order to obtain benefits.
The insurance company dragged on and on, appealing everything, etc., meanwhile, the poor
plaintiff/insured had to borrow money at exorbitant rates to survive. After months of more legal
wrangling, but usually nothing more than stony silence from the insurer, and after the insurer had
finally exhausted all avenues, it paid the judgment, including the multi-million dollar punitive
damage claim. (Interesting note in regards to the punitive damages. The plaintiff's attorneys
were concerned in the trial when the jury walked to the jury room after all arguments had been
heard, and none of them even looked at the plaintiff. The immediate concern was that they just
did not like the plaintiff for whatever reason–can happen. But when they gave the plaintiff eve-
rything they had asked for, and awarded a multi-million dollar punitive damage award, they told
the plaintiff and attorneys after the trial that they all knew what the decision was going to be, but
they had to argue as to the amount of the punitive damage. They felt that they should not give 50
or 60 million in punitive damages as the plaintiff probably could not handle that much sudden
wealth!)
RULE: NEVER MARKET A DISABILITY POLICY OR DISABILITY PROGRAM
UNTIL YOU ARE ABSOLUTELY SURE THAT (1) YOU KNOW THE DEFINITION OF
DISABILITY AS IT IS REPRESENTED IN THE POLICY, AND (2) THERE IS NO
INDICATION THAT THE INSURER CONTESTS CLAIMS ON THE BASIS THAT THE
DEFINITION OF DISABILITY IS DIFFERENT THAN STATED IN THE POLICY.
KNOW THE CLAIMS PHILOSOPHY OF THE COMPANY.
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STUDY QUESTIONS
1. Insurance companies make most of their money
A. by playing the stock market and issuing junk bonds.
B. by not paying claims.
C. on investments.
D. from patents.
2. An insurance company must operate
A. on the implied promise of good faith and fair dealing.
B. by paying the minimum amount of claims.
C. as mutual companies even though they may be stock companies.
D. on a legal, but unethical, basis, or otherwise they would not be profitable.
3. When an insured has a problem in collecting from an insurer, the Department of Insurance in
that state
A. can sue the insurer on behalf of the insured.
B. can hire attorneys to represent insureds in court.
C. files suit under federal law.
D. investigates to see if they are violating unfair practices law, and if they are, they can fine
the insurer.
4. If a disability policy is determined to be an ERISA regulated policy,
A. the policyowner can sue the federal government for non-performance.
B. all that really happens is that the agent cannot collect commission.
C. state law is preempted by federal law, there are no jury trials and there are no
compensatory or punitive damages.
D. the policyowner is automatically awarded damages.
5. An ERISA organization that issues health coverage must, according to federal law,
A. must sell coverage to only one employer.
B. may sell insurance of any kind to any person or organization.
C. represent themselves as insurance companies and sell by insurance agents.
D. must be licensed by the state.
6. When marketing a disability income insurance policy, the agent
A. if forbidden by law to go into details as to what "disability" under the policy entails.
B. must understand "total disability," "partial disability," and "disability" thoroughly and be
able to explain it correctly to the applicant/client.
C. must hold a federal agent's license.
D. need not fully understand policy provisions, as "caveat emptor."
ANSWERS TO STUDY QUESTIONS
1C 2A 3D 4C 5A 6B
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CHAPTER SIX – REPLACEMENT, CHURNING AND
ILLUSTRATIONS
To the general public and the majority of consumers, Life Insurance products used to have a
squeaky clean image—after all, they were the ones the paid to have Grandpa buried and kept
Grandma from losing the family home. Huge hotels and office buildings were built because it
was financed by an insurance company (who always notified the public as to who it was by the
erection of a sign during construction). The only bad "rap" against life insurance for years was
the reputation of the agent as being persistent. Even so, that usually was said with a smile and
when Junior was born, the parents would call in a life insurance agent to help them make sure
that there was money available in case something happened to the bread winner, and in some
cases, even made sure that Junior had some college funds when he turned 18.
About 30-35 years ago, the life insurance industry woke up one morning and found that they
were losing market share for the American dollar. The problem was, to put it simply, was that
interest rates on investments were climbing through the roof while most life insurance policies
were struggling along with an interest rate of around 3% for cash value growth. Life insurance
policies continued to increase cash values—which were considered as an "investment" in the pol-
icy as it could be borrowed against, or even obtained by cashing out the policy. Companies and
agents, in desperation, could only compete by offering higher returns, which was, at that time,
selling term insurance (insurers do not make much money on term insurance and agent commis-
sions are very low) and taking the difference between what the term insurance premium cost and
what they would have to pay for Whole Life insurance, and putting that amount into invest-
ments—usually mutual funds. "Buy term and invest the difference" was the battle-cry of the in-
surance agents.
This meant that persistency (how long an insurance policy stays on the books) tumbled as
more and more Whole Life policies were being "rescued" and a replacement market developed.
There was even a successful company that would, for a fee, determine the cash value of a Whole
Life (ordinary) life policy, or any policy with a cash value, determine the amount of term insur-
ance that was needed, and go through the required actuarial calculations to replace the policy,
which eventually even included issuing the new policy on the insurer's paper.
US insurers could not compete otherwise because of certain requirements in the nonforfei-
ture laws—a highly technical requirement designed to protect policyholder's cash values basical-
ly—but brilliant minds came to the fore and the Universal Life Insurance policy was introduced.
The first company to market Universal Life (UL) was a life insurance company owned by a se-
curities firm, incidentally. Soon nearly every company was selling UL policies, even though
actuaries were questioning the profitability of the product.
In any event, now instead of replacing a Whole Life policy with Term, now it was replacing
it with Universal Life (UL), a policy that was extreme flexible and that could be used for many
purposes and still remained an insurance product, subject to certain technical requirements. Va-
riable Annuities had been formed to appeal to investors, but that required security licensing of
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the agents. The Variable feature was attractive, however, so the UL then evolved into Variable
Universal Life Insurance, the best of both worlds. But it was a heck of a replacement tool.
These new policies had two Achilles heels (so to speak): replacement and illustration. Poli-
cies were being replaced and agents were getting new commissions. PROBLEM. Secondly, in
selling a policy that allowed the insured to participate in the results of the market—when the
market went up, their earnings went up, and vice versa—projections were necessary to show just
how much money the insured could look forward to having over a period of years. SECOND
PROBLEM.
REPLACEMENT
The news media discovered that some agents were replacing many policies with others,
from which they received new commissions. When this was done on a mass basis, it started be-
ing called "churning"—which was a much better term than "twisting" which, as everyone knows,
is illegal. One news story from The Milwaukee Journal Sentinel in 1996 is most informative—
entitled "Insurer's Churning Detailed."
Peter Katt knows of one case in which a Prudential life insurance agent sold a Minneapolis
man more than a dozen policies over several years, assuring the purchaser that the dividends
from his old policies would pay the premiums on the new ones.
"Actually, the agent was funding the new policies by killing off the early ones purely to
generate commissions," says Katt, a fee-only life insurance adviser from Mattawan, Mich.,
who was called in by lawyers to advise policyholders who sued Prudential over its practices.
Katt compares it to a doctor who sets up a transfusion in a hospital ward to save one patient
by sucking the blood out of another, and then repeating the process down the row, killing off
successive patients to collect more and more money. (Note: This wording seems a little ex-
treme…)
A settlement of $210,000 plus costs has been offered in the case, which typifies the sort of
"piggybacking" and "churning" problems that led to a $35 million fine imposed last week
against Prudential Insurance Co. of America by a task force of 30 state and local regulators.
Jim Hunt, an actuary for the Consumer Federation of America, advises Prudential customers
who think they might be eligible for some of the $100 million or more that Prudential will
pay out in restitution to sit tight.
"People ought to just relax for awhile," he says. "Prudential will notify them."
Hunt believes that policyholders with the best chance of collecting money will be those who
were persuaded to borrow against an existing insurance policy to buy a new one so-called
piggybacking "unless you were given full disclosure about it."
Churning in which an agent talks you into dropping an existing policy to buy a new one also
is a prevalent practice that usually makes no economic sense for a policyholder.
That's because the value of a permanent life insurance policy builds slowly during the first
few years, when commissions and expenses eat up most of the premium. The money you've
spent is lost if you let the policy lapse.
Yet it goes on all the time.
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"Raiding your own company's policies has pretty well stopped," Hunt says. "Raiding every-
body else's policies has not diminished as far as I know."
A spokesman for the American Council of Life Insurance called last week's developments
"an indication that the regulatory system is working" and Prudential's response an indication
that "the industry is serious about dealing with these problems."
But Glenn Daily, an independent, fee-only insurance consultant in New York City, thinks at-
tention to life insurance abuses will "be moving down the ladder of size to smaller compa-
nies."
"There are more lawsuits now," he says. "And that has more impact than regulators are hav-
ing. The life insurance industry understands lawsuits. I'm not sure they understand ethics."
Daily, who discussed life insurance churning in this column a year ago, says it is not just ro-
gue agents who do this. There is pressure on all agents because there are too many insurance
salespeople chasing too few prospects.
He estimates that for each of the nation's 200,000 full-time agents, there are only 133 likely
customers.
And many agents don't understand what they're selling. A life insurance policy is one of the
most complicated financial instruments you can buy.
"These guys aren't financial analysts," Daily says. "They're salespeople."
So they make promises without any way of knowing if they can be kept. And more of these
sale pitches will be coming back to bite the parties involved.
For example, the next big potential source of life insurance litigation, according to Katt, will
be over what he calls "vanishing premium" promises made by agents during the 1980s.
"Buy this policy, make just seven payments and it will be fully paid," was the claim.
"They went nuts with this for six or seven years," he says.
It actually will take 27 years to pay off those policies, according to Katt, because the divi-
dend rate on which the assumption was based was at a historic high of 12.5% in 1984 and
1985 (against a 6.5% postwar average) in Prudential's case.
"We're claiming that they had a duty to tell consumers how implausible the vanishing pre-
mium idea was," Katt says.
Prudential did not return my phone calls.
The biggest scam today? According to Katt, it's "exaggerated guarantees" in which guaran-
teed performance comparisons are made by some agents to get consumers to switch policies.
Guarantees that are out of line with industry norms probably are not supportable, he says.
Insurance companies may be powerful, Katt notes, but they aren't governments and can't set
interest rates or collect taxes. "(They) don't print money or have aircraft carriers," he says.
"How can they make these promises?"
It wouldn't take an international financial meltdown or a lethal airborne virus wiping out half
the world's population to make the "guarantees" impossible, either, says Katt.
"Just a balanced budget in Washington," he says. Insurance companies invest heavily in
fixed-income investments. Lower prevailing interest rates that could result from a shrinking
federal deficit would throw off the assumptions on which the "guarantees" are based.
"Life insurance," he says, "is a legally regulated criminal enterprise."
82
CHURNING AND TWISTING
A rash of policyholder complaints about misleading sales practices has fueled a growing
number of class action suits against life insurance companies. The offending practices usually
take one of two forms: "churning" (also known as "twisting") or promises of "vanishing pre-
miums."
VANISHING PREMIUMS
Life insurance companies take the money they collect in premiums and invest it - that's how
they make their money. In the case of permanent life insurance policies such as Whole Life and
Universal Life, companies then apply some of those investment earnings back to the value of
your policy.
During the early 1980s, interest rates were high and it looked like they'd keep on climbing.
So, life insurance companies projected the rate of return from investing today's policy premiums
to the point to where the policy would be paid off in a few years—seven was common—and the
insured would never have to make any premium payments on that policy again. [Comment: In
retrospect, one has to wonder at the gullibility of grown adults…]
As it turned out, those rosy projections weren't accurate. Interest rates fell, and customers
who'd been told their policies would start paying for themselves kept getting premium notices in
the mail. Angry policyholders protested, only to be told insurance company projections weren't
guaranteed. But if they wanted to keep their insurance coverage, they would have to start paying
premiums again—regardless of what the agent told them. In some cases, customers were able to
prove they were not informed of that when they signed up for their policies. As one would im-
agine, the insurance Departments heeded the call to battle and results were encouraging.
The Missouri Department of Insurance claims since the mid-1990s, state regulators and
class-action litigation nationally have secured hundreds of millions of dollars in policyholder
awards for "vanishing premium" violations.
Texas insurance commissioner Jose Montemayor says some common sense can help protect
you from "vanishing premium" or "churning" scams. "Ask yourself whether the agent has your
best interest in mind or is just trying to get a higher commission," Montemayor says.
CHURNING
The largest churning scandal in the history of the insurance business involved some of the
big boys," namely Metropolitan Life and Prudential, plus State Farm and Nationwide. Smaller
companies were also affected when the crackdown occurred as the hungry and successful law-
yers broadened their net to include even the smallest. Now, let's discuss how this all happened.
Way back in the early 1980s, as stated earlier, when interest rates were in the solid double
digits, there was a hoped-for rapid increase in the sale of "interest-sensitive" life insurance poli-
cies. The primary policy was Universal Life and also Variable Life policies to a lesser extent.
This is "old news" to anyone who was in the life insurance business at that time as the Wall
Street Journal and the New York Times, and every other major newspaper in the country printed
article after article—everyone wanted to be a "giant killer" and take on the large insurance com-
83
panies. This was all a result of the push the insurance companies had made for their new prod-
ucts—referred to by some agents as "go-go" products.
What is really interesting and not really presented to the public was the fact that the life in-
surance companies pushed hard for NEW customers, making it plain that they much preferred
that these policies only be sold to new customers. Some even reduced commissions on replace-
ments, and all replacements were, supposedly, reviewed by the home office before acceptance.
The companies knew that "churning" existing money was not in their best interest.
Sure they might replace some of the ABC Company's policies and get new premium that
ABC lost, but realistically, they were also frightened that their own company could become the
"ABC" company. Besides, they had to pay new agent commissions on the churned business, and
at the end of the day, there really was not that much gain in premium income—sometimes there
was a loss even though different business had been written.
The agents, on the other hand, set their sights on far easier, far more vulnerable targets: ex-
isting customers with existing Whole Life policies that had substantial built up "cash value." The
sales pitch went something like this: It simply didn‘t make much economic sense for policyhold-
ers to continue earning dividends in the single-digit range on Whole Life policies, when they
could instead be earning double-digit returns by buying these new interest-sensitive policies.
It did not take long for some agents to realize that Whole Life policyholders usually had
enough "cash value" in their policies that could be applied to the new interest-sensitive policies
and that way the policyholder did not have to pay premiums for some time in the future. On top
of that, some policyholders could replace their Whole Life policies with a higher death benefit,
and premium payments, while they would eventually be higher, didn't have to be paid right
away. All that PLUS, policyholders could have faster cash value buildup with the new policies
and as the market rose, so did their "investment."
This is almost too good to be true and with sooo many policies to be replaced, this was set-
ting a prairie fire in the insurance business leading to ultimate widespread abuse. There was a lot
of money to be made, so with a few misplaced words, the insurance company has new business
so it is happy. The client has all the good kinds of policies and he doesn't even have to pay for it
right away—maybe never! And the agent, if he got enough replacements and first year commis-
sions, he can winter in Florida every year.
It was just too easy to mislead (just a little) the economics of the situation in order to con-
vince even the most tough-skinned nay-sayer that he needed to take advantage of this deal.
Temptation was too great all the way around. Not only was there money to be made, there was
the satisfaction that the agent could shaft (to treat unkindly, look it up) the insurance company,
the insurance company could shaft another insurer by getting some of its business; and the in-
sured could shaft the former insurer. Win, win, win (almost). But how about the companies that
had a persistency problem due to so many of their policies being replaced (churned)—and that
included the "big boys?" They could either complain, sit on their huge assets, or join the fray
(which is what some of them did).
"Ethics" —who cared?
This party didn't last much past midnight (so to speak) and the interest rates started declin-
ing. At first it was a modest decline and the insurers just tightened their belt, but the rates keep
tumbling. [Interesting sidelight, the interest rates paid today on interest-sensitive plans are about
what was being paid on the old Whole life plans when all this occurred.]
84
Premium payments that were not supposed to be due for years—if ever—suddenly became
due and payable. What was the policyholder to do? He had two choices, either lapse the policy
and forget it, or pay the premium. Most paid the premium because otherwise they would be out
of life insurance and even if they could qualify for another life insurance policy, the rates at his
now (attained) age would price it almost out of sight.
Policyholders were irate, they had been lied to, obviously, and they were "ticked" off, to say
the least. Insurance companies were investigated, sued and there was all kinds of accusations
thrown around.
Anyone who has been in the industry for any time knows that far-and-away the majority of
the insurance people, from company Presidents down to the agent, are honest and ethical people.
So what happened? A few "bad apples" actually spoiled the "barrel." There was a lot of finger-
pointing, but when all was said and done, there were just a few unethical people in key company
positions who, with the assistance of uncaring and unprincipled agents, jumped on the roller
coaster for the ride to make a few bucks. Some, unfortunately, made a lot of money, but if they
had replaced policies according to their insurance company guidelines, what could be done? In
some of the most flagrant cases, there were lawsuits that dribbled all the way down to the agents.
The unfortunate result is that the life insurance industry lost face and these few caused a
blemish on an old and very honorable industry. If the scandal that erupted was confined just to
the very large insurers, that would be bad, of course, but opportunist lawyers have gone after not
only the companies, but general agencies and in some cases, individual agents. The ones that
really got hurt were the smaller insurance companies.
If one were to be judgmental about this situation, they would not shed too many tears for the
demise of the reputations of some of the smaller companies—or the actual demise— because
they were obviously involved and implicit in the scandal. With a large company, when less than
10% of their business is concerned with replacement business, either being replaced or replacing
other policies, this is of minor importance. Unfortunately, some of the big names were "dragged
through the courts" and were "exposed" by the press, and it will take a few more years before the
stigma of unethical behavior finally wears off.
Some of the smaller companies, on the other hand, were necessarily aware of what was
going on as with some, the majority of their business was replacement. Not only were they re-
placing policies rapidly, they contracted with agents to do the replacing and replaced policies
became the largest part of their new business. There were trips (Aruba was popular) for those
who "qualified" by premium income, company cars, and bonuses that were outstanding in this
business. However, many of the smaller companies just were not able to withstand the assault by
lawyers and regulators, and had to either merge or sell their remaining block of business and
close their doors. (Most of them merged and even if the business was not worth what it should
have been, agents contracts are like gold to some of the insurers.)
The companies and the agents still lost because of negative publicity and diminished trust,
and policyholders will also lose because of a generally weakened life insurance industry.
In Florida, for instance, the Insurance Department arrived at a $5.5 million settlement with
American General Insurance Company and affiliated and associated companies, who all coope-
rated in the settlement. From 1982 through 1997, up to 207,000 Floridians who bought life in-
surance from eight American General Corp. companies were victimized by deceptive sales prac-
tices including churning. The eight life-insurance companies agreed to pay a total of $5.5 mil-
lion to settle charges that they routinely engaged in deceptive sales tactics.
85
Additionally, the agreement gives Florida an "outreach program" to help provide quick resti-
tution to the life-insurance customers who bought up to 231,000 policies from the American
General companies during the 15-year period. Florida had also negotiated with Prudential and
John Hancock and received large settlements from those companies also.
The "churning" scandal is now in the past, much sooner than most believed was possible.
The reason that it was handled so rapidly was that the lawyers were successful in representing
their wronged clients, and the insurance industry "bellied up to the bar." While internally, there
were upheavals, to the general public, the insurance industry is about back to where it was prior
to the scandal. On the other hand, a life insurance agent is considered just above lawyers and
used car salesmen in the eyes of the public, but that was that way even before "churning."
This is an enigma—insurance agents have a well-deserved reputation of being persistent, to
the point of being irritating sometimes. People do not like this, and this does not help their popu-
larity. But, some believe, rightfully so, that is it simply the fact that people do not like to consid-
er their death, and a life insurance agent is a reminder that they will die someday.
If you do not agree with this theory, here is a test. The next time you are on an airplane and
you want to read or just not visit, one of the first things out of the seatmate's mouth is, "What do
you do for a living?" Just tell him, "I'm a life insurance agent." 99 times out a hundred he will
say something inane and then not bother you the rest of the trip. (The 1% are probably agents
also…) It works.
Lesson in this story is that if life insurance companies had been more diligent in supervising
agent's sales practices, if the agent's selling interest-sensitive policies been completely honest
with policyholders in describing the downside, many experts and pundits believe that this "mess"
could have been avoided, or at least mitigated.
Others, many of whom are intimately involved in this situation, honestly believe that the
whole thing was human nature. The agents were not convinced that they were lying—lying
agents could not have sold that many insureds on replacing their policies. Insurance companies
were desperate to put a plug in the dam as their business was being replaced by their insureds
taking their money out and buying mutual funds or other investments, often without the know-
ledge of their agents. Many companies were slowly bleeding to death so it is rather difficult to
criticize the executives who were preserving the stockholder's (or with mutual companies, the
policyholder's) assets. State regulators were aware of what was happening, but did not have the
legal means to really stop it, and by the time that the regulations were in place, it was a little late
for some. Credit must be given to the regulators as they worked overtime to stop this draining of
business, to stop the training and recruiting of replacement agents, and of working with the com-
panies in settling policyholders' complaints.
There is one theory in respect to what attributed to these situations, which, if reversed, could
have helped at least slow down the replacements:
As a whole, Life Insurance Agents rarely, if ever, contact their policyholders after
they sell the policy. They do not SERVICE their business, as property and casualty agents
usually do.
If life insurance agents would just keep in contact with their customers, and keep a line of
communication open, they would have had a chance to have stopped this as it would have been
in the interest of the insured and the agent to have stopped the replacement, or on the other hand,
86
the agent would have been able to work with his client so that he would have had the coverage
that he needed and continued with the same company on another interest-sensitive policy.
It has always been a mystery to many who have spent many years in the life insurance in-
dustry, as to so many why life insurance agents do not, as a matter of course even, maintain a
relationship with their clients. Some feel that the agent doesn't want to take a chance on the poli-
cyholder having second thoughts, or asking some questions that they cannot answer and would
appear dumb to the insured, or, and this is possibly the main reason, they are just too lazy.
Some agents will never, unless ordered to do so, even deliver the policy!
RULE: ALWAYS, GLADLY, DELIVER THE INSURANCE POLICY TO THE
INSURED. IF DELIVERY IS NOT POSSIBLE FOR SOME REASON, SET UP AN
APPOINTMENT WITHIN THE NEXT 30 DAYS TO REVIEW THE COVERAGE.
Some insurance companies require this contact. Bless them, and it is a fact of life that their
persistency is excellent—which is good for the insured, the insurance company and its owners,
and the agents.
TODAY'S MARKET
In the financially robust 1990's, the public became more and more disillusioned with life in-
surance policies and life insurance companies, some of it due to the adverse publicity the indus-
try had received, but also the tedious guarantees and the failure of the industry to deliver on the
promises created additional resentment. The 1980 tax revisions should have made the newly in-
troduced single premium Variable Life policy, but it failed to keep pace with the growth in other
securities so it was met with a yawn. Variable annuities, on the other hand, were less compli-
cated and less expensive and were preferred for high net-worth investors.
The Gramm Leach Bliley Act of 1999 allowed banks, insurers and securities firms to sell
each other's products, with the result that insurance companies began advertising themselves as
financial services, manufacturers, providers, and even just "corporations." Some even dropped
"Insurance" from their names but added other words, such as "financial." Of course, insurance
professionals started marketing themselves as financial professional and financial services advi-
sors, offering mutual funds, annuities, private placements, etc.
Basically, the trend now is that there is less of a difference between how insurers, banks and
investment broker-dealers approach customers these days.
Interestingly to those insurance "purists," variable annuities have evolved into a single pre-
mium Variable Life insurance (SPVL) market and are used more and more in the financial plan-
ning process. Variable Annuity sales decreased in 2001, and those who do purchase VAs indi-
cate a preference for contracts which offer insurance benefits, such as income and death benefit
guarantees.
Life insurance companies have strived to develop new products and along with new legisla-
tion, plans such as Variable Universal Life has been developed. It was not until 2001 when pro-
ducers started reporting an increase in life insurance purchases. The economy and the war on
terrorism had something to do with that. For whatever reason, individual life sales, particularly
Universal Life plans, rose by annualized premiums, a healthy 18% since 2000. Fixed annuity
sales rose by 36% in 2001 over 2000, and Equity Indexed Annuities increased over this year by
20% .
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ILLUSTRATIONS
CREDIBILITY OF ILLUSTRATIONS
Many potential life insurance policyowners who are confronted with the fancy illustrations
and figures presented by insurance agents are often enticed by the most impressive figures that
illustrate a moneymaking financial future. However, it is most important to know the type of
methods used by insurers to calculate these projections and recognize the problem with these
calculations.
The credibility of illustrations is the second major reason for ethical difficulties with the way
that the insurance industry and insurance agents are perceived by the general public. Prior to the
interest-sensitive policies being made available, non-participating, guaranteed cost life insurance
was a strong part of the market. It performed well as advertised and projected well when com-
pared to most of the mutual companies, which had been generally decreasing their dividends and
projections since the 1930's.
A word about dividend projections here, as this was the first time that life insurance policies
were sold at a certain premium, however, the policyholder was entitled to dividends that were
declared by the insurer annually, and the policyholder could take the dividend in paid-up insur-
ance, added to the cash value, or other methods from the active minds of the actuaries. Non-
participating insurance was devised somewhat to counter the mutual companies' projections.
Then the Supreme Court ruled that the "dividends" of the mutual companies were really return of
premium—which is what they really were all along, although the mutuals could insist that the
Board of Directors had to agree that the money was available. After all, the mutual companies
were owned by their policyholders and were (supposedly) operated in their interest. There are
those who maintain that a policyholder has no more influence in the company's management
than a non-policyholder—perhaps, en masse they could influence management, perhaps.
Anyway, mutual policies were sold with "projections."
In 1952, according to remarks made by F. Stitt, CLU at an industry meeting in 1990, a 45
year old male could purchase $100,000 of Whole Life from Mass Mutual at $4,089 with a 20-
year average net payment projected at $3,195. Travelers would issue the same policy with a
guaranteed 20-year average payment of $3,100. (For those who do not have a calculator handy)
Travelers guaranteed payments were $95 less than Mass Mutual's projected net payments with-
out any adjustment for interest on the higher Mass Mutual in the early years. With the advantage
of being able to look back, it turns out that at the end of 20 years (by 1972) the total net pre-
miums paid to Mass Mutual was still $53 more than the non-par premium of Travelers in 1952.
Based on projections and history, Travelers was the best buy.
Okay, now comes the fun part (?)—Mass Mutual says that they would have had the best buy,
by far. The 20 year net payment on a Mass Mutual policy bought in 1952 was, in fact, $2,526,
taking into consideration the actual results of dividends and updated programs offered by Mass
Mutual, showing that the dividend increases in the 1980s have more than offset the difference
between them and non-par companies. In this case, mutual companies outperformed non-par
companies, and many stock (non-par) companies issue mutual policies so as to compete.
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So what does this have to do with anything? Well, the 1952 assumptions were quite simple
and easy to understand and most companies used similar interest rates, mortality and expense
assumptions—still, they all had to follow the siren's songs of steadily rising interest rates with
the results that the dividends soared. Today, every company has its own secret formula of yield,
mortality, expense and persistency that it uses to arrive at the premiums.
Using more up-to-date premiums, for a $250,000 policy (Policy A), for a 50 year-old male
non-smoker, the premiums would be $5,247.50 annually for a little more than 11 years. The
cash value would have grown from 6.25% to $172,681 in 30 years.
Another policy (let's call it Policy B) promised $90,000 more in cash value within the 30-
year period than Policy A , as it would be effectively offering a 8.12% rate of return, and the po-
licyowner would stop paying premiums one year earlier than under Policy B.
Policy B would seem to be the better policy, right? However, let's look at the 4 principal as-
sumptions used in premium rating Policy B.
1. The mortality rate is assumed to improve by one percent per year, ergo, policyowners
will live longer and payouts will be minimized.
2. Interest rates will increase. The rate of return on Policy B is dependent on the interest
rate being a half percentage point higher than the current rate.
3. Irrespective of the impact of inflation, expenses paid by the policyowner would de-
crease over time.
4. Ten percent of policyholders will cancel their policies annually, thereby passing those
benefits to remaining policyowners who would enjoy persistence bonuses after main-
taining their policies for 15 years or more.
When put to the test by actuaries, reality did not conform to the assumptions of Policy B, and
Policy A policyholders actually enjoyed higher benefits than those who chose Policy B.
Hard to believe today, but in 1994, for instance, illustrations were showing a 12 percent rate
of return for their investments. Since the results over the past 20 years shows that to be high
(way high), present rates are around 5.01 percent and some experts believe that this might not be
an accurate projection within a long-term historical context.
LIFE INSURANCE ASSUMPTIONS
Obviously, since actuarial science does not include a course in crystal ball gazing (does it?),
certain "assumptions" must be made to come up with the premium. These assumptions can be
based upon a mortality table, the experience of the insurer over the past 5 years, projected im-
provements into the future, lapse assumptions (persistency) (which are very often unrealistic)
and or any number of mathematical processes.
Current yield rates are often quoted, usually without reference as to whether they are net or
gross, and if net, net of what? Do companies increase expense and/or mortality assumptions in
order to advertise high-yield assumptions? Don't bother asking the insurer as assumptions are
the "family jewels," just as the source code is to programmers. Some think that the insure com-
panies' secrecy is nonsense, a holdover from the 50-60's when the industry did not want anyone
to know how inefficient it was.
Perhaps the question should be—does it really make that much difference now? Answer
should be "probably not" as much difference as investment income, both on the company's own
internal portfolio and that of interest-sensitive policies.
89
PROBLEM – THE PUBLIC TRUST
During the Great Depression, insurance companies would send personnel from the home of-
fice to local offices to help process policy loans promptly when the banks were closed or in de-
fault, or delaying payment on withdrawal requests No one lost money on their life insurance.
Public trust of insurance companies was very high
Just prior to the advent of interest-sensitive plans, life insurance companies were notoriously
overly cautious and inefficient investors—not all of it the fault of the insurers as much as it was
because of tight regulations. But when the interest-sensitive plans started making headway, the
insurers had to have more competitive products and the only way that they could do that was to
have a more aggressive investment philosophy. One major California insurer even invested
heavily in "junk" bonds and was offering highly competitive plans until the Insurance Depart-
ment shut them down as the regulators were concerned that the policyholder's money was not
being safely invested. (Interestingly, the company had a higher rate of return on investments,
which was passed on to the policyholders in their interest-sensitive policies, with no defaults,
until the regulators shut them down.) One of the problems was bad publicity by a securities
dealer who invested his client's money in junk bonds, and when some of them tumbled—as is apt
to do in these situations, the SEC went after him full bore. The adverse publicity made "junk
bonds" a bad word to investors even to this day, although still most people do not know what
they really are except for those who made millions off them-but I digress.
When using illustrations to market insurance, it is wise to be aware of the
financial position and rating of the insurer and share this with the client.
Agents who are professional and concerned about the loss of trust by the public have a con-
undrum when they insist that the insurer would only invest in high-quality investments so that
their financial rating will increase. Yet at the same time, they are the ones that want interest-
sensitive products that can compete on the investment level with returns from mutual funds and
other such investments. It is a little difficult to have it both ways.
MAKING THE INSURANCE INDUSTRY MORE TRUSTWORTHY
In 1990, some of the better educated and most successful life insurance agents were pressur-
ing the insurance companies to make every effort to gain back the public's trust. At that time,
agents were concerned with banks entering the insurance business, but it was felt that they would
not push for insurance sales and any interest would be short term, transaction oriented and insur-
ance would be treated like a commodity. On this point, they were right on, as that is what hap-
pened.
A second item of concern was rebating as California and Florida struck down their rebating
laws and agents were concerned that the rest of the country would follow. Didn't happen be-
cause the regulators listened to the concerns and since rebating laws had been passed, simply
made the requirements so strict that it was not profitable to rebate—matter-of-fact, nearly im-
possible. And that is a good thing.
90
They also made suggestions as to commission design. Suffice it to say that there have been
problems with the commission system for years—particularly of the high first-year commission
and much lower renewals, mainly since property and casualty agents operate for the most part,
on level commissions. Nothing much has happened, and probably won't, since the old adage of
"life insurance is sold, property and casualty insurance is bought" still rings true, plus the fact
that P&C business is mostly for relatively short term and must be adjusted, reviewed and re-
newed regularly. Therefore, P&C agents must be paid on a level basis, otherwise, human nature
being what it is, there would be little if any servicing of the clients.
POLICY ILLUSTRATIONS
Non-Variable Life insurance policies have two basic documents that are delivered to the new
policy owner, the policy and a policy illustration. If the plan is a Variable UL or Variable Whole
Life policy, then there must also be a prospectus delivered. The policy is a legal contract as it
specifies the terms and conditions under which the policy is issued and the death benefit paid.
The policy will specify the insured, the death benefit, and the premium (whether stipulated or
flexible).
The policy illustration is really just a finely crafted work of fiction, stating and projecting va-
riables (changeable ones at that) far into the future with assumptions that are current but not
guaranteed. And what do they do with these assumptions? They are treated as constants. Still,
these two documents are unrelentingly forced together by insurers and their agents and by the
expectations of the marketplace.
Policy illustrations, instead of being part of the legal contract (policy), are just marketing
documents that attempt to highlight the best aspects of the financial potential for the policy—
nothing more and nothing less. It is no better or no worse than advertising materials whose pur-
pose is to attract the potential buyer to buy this policy (instead of that other policy).
However, since the invention of the flexible premium Universal Life policies in 1979, the il-
lustration has become something of a chore that it cannot possibly or reasonably accomplish—to
solve the dilemma that it is hard to sell a policy when the policy has no premium in the tradition-
al sense.
Therefore, the illustration has now become the tool to calculate a premium based on some
integral and incessant assumptions about future expenses, policy earnings, profit margin and
mortality charge. The insurance company does reserve the right, however, to increase those ex-
penses and/or change the policy earnings expectations, and by doing so they are repricing the
policy over time, subject to the maximum charges, and in the case of Universal Life, minimum
crediting rates as itemized in the policy.
This is a practical description of a life insurance policy illustration and is not intended to
show that there is anything inherently wrong with Universal Life or Variable Universal Life (or
indexed Universal Life) or their illustrations. It is just that agents must fully understand the dif-
ference between the policy and the illustration, and have a pragmatic and useful approach to
manage such policies.
There is a big difference between a life insurance policy and it's illustration, and it
cannot be emphasized enough that the illustration is just that—an illustration—and is not
an inherent part of the life insurance policy.
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A series of illustrations from Revealing Life Insurance Secrets, Richard Weber author, illu-
strated the different in what the policyholder had to pay for a million-dollar policy at age 45, in
good health.
Non-par Whole Life $15,255 guaranteed
Par Whole Life $18,810 guaranteed
No-Lapse UL $8,041 guaranteed
UL $10,400 calculated funding premium
Variable UL $7,178 calculated funding premium
The details as to how these premiums could vary so much depended upon (Quick class,
what is the magic word?) ASSUMPTIONS. These figures were actually computer generated,
hence the "accuracy" of the numbers. Much of the unsuspecting public feels that if a number is
"exact" it must be correct.
What to believe? In 1992, the Society of Financial Service Professionals attempted to help
agents, insurers and customers to understand the confusing and difficult insurance language and
in particular, the assumptions that create a "good" policy illustration. The Society came up with
an Illustration Questionnaire, and the introduction states:
"…sales illustrations are useful in developing the best combination of policy specifications to
achieve the buyer's objective. However, illustrations have little value in predicting actual
performance or in comparing products and companies … sales illustrations are usually de-
signed to present potential benefits and costs under a set of non-guaranteed assumptions
more optimistic than the guarantees … (and) the risks associated with the possible inability
of a product to achieve the higher illustrated benefits, or lower illustrated costs, than those
generated by the guarantees are borne by the policyholder."
The National Association of Insurance Commissioners (NAIC) in 1995, in its presentation of
Model Regulations for life insurance policy illustrations, defined the purpose of an illustration as
"Clearly disclosing how the policy being illustrated will work, distinguishing that
which is guaranteed and that which is not."
Also, the NAIC said, the illustration must be "understandable to all parties involved in the
sale of insurance." Regardless of the efforts of the NAIC over this 12-year period, today's illu-
strations are just not capable of accomplishing the intent of the NAIC's objectives. One of the
main reasons is the advance in the technological ability to create all sorts of "what-if" situations
never before realized, to the point to where a computer-generated illustration can prove that the
world is square and that the sun will come up every weekend if so desired. So, what to do, what
to do?
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REALITY IN PRICING LIFE INSURANCE
It was remarked recently that if something like life insurance, a basic commodity to most,
can be priced so differently by so many different policy illustrations, it would not make any
sense logically. There are more than 1500 life insurers domiciled in the United States—plus
several from Canada that operate here—so there certainly are competitive forces at work. As a
general rule, companies of the same type that market the basically-same product are at work, so
it can be expected that these companies incur generally the same broad costs and have the same
basic returns over the long periods of time characterized by insurance companies. It is not the
same as describing the differences between a Volkswagen and a Rolls Royce.
When life insurance is priced, there is always the non-guaranteed hypothetical illu-
stration, and then there is reality.
According to the "Occam's Razor" principal (named after William of Occam):
One should not increase, beyond what is necessary, the number of
entities required to explain anything. (Principia Cyberetica Web)
Applying this principal to determining the true value of an insurance risk, the true fact-of-
the-matter is that for any given age, gender, medical, and financial risk profile, there is (or should
be) a level premium that would be completely sufficient and profitable for the policyholder and
the life insurance company in respect to the life of the insured and to the providing of a death
benefit of the insured regardless of when that may occur. When it is attempted to charge or pay
an amount that is lower than this number, which is fully sufficient and guaranteed cost, this
would create a level or risk that is not known to the typical policyowner and cannot be fully de-
termined when the insured dies. In other words, one might way, succinctly, "Keep it simple, stu-
pid."
CONCLUSIONS
To start at the top, as it were, all conclusive analysis and research has determined that the du-
ration for fixed income for retirement withdrawals reaches its maximum at the five-year period.
Therefore, other investment opportunities, such as a short-term government bond ladder for fixed
income may be appropriate. Studies also indicate that mutual fund bond funds are not the best
vehicle for a retiree's fixed income portfolio because they are burdened with various fees, and
control of the portfolio it out of the hands of the investor. Fixed income mutual funds are gener-
ally "Institutional Funds" with less stringent fees. However, these funds target institution and
require a large commitment to participate (like for $5 million in some cases). Obviously, they
are not designed for or marketed to the average investor. Therefore, the bond ladder appears
more appropriate for the fixed income portion of a retirement withdrawal portfolio.
93
In respect to mixed allocations, it would appear that there is more importance of asset alloca-
tion in retirement planning. The best arrangement would probably be an ever-moving target that
is flexible enough to change annually. Obviously, this is riskier and more volatile, but such in-
vestments with decreased initial withdrawals seem to be the best for long-term-strategy. In addi-
tion, the ability of latitude regarding mandatory withdrawal amounts is most important as this
allows for the flexibility that is needed during the time when asset value decreases and the cash
flows are erratic.
Finally, there seems to be no single strategy to analysis and selection of the optimal life in-
surance policy and program, regardless of the decision for Whole Life, term, traditional or inno-
vative insurance strategies. Life insurance strategies are best tested regularly and reviewed on an
annual basis so as to be certain that the security and flexibility that is needed for the optimal in-
surance approach are being achieved. Regardless, there are a number of universal guidelines that
can be drawn.
There is little argument that consumers will benefit from a diversified portfolio, the most
ideal investment portfolio is clearly depending on the unique resources and needs of each indi-
vidual investor. The strategic objective for insurance as an investment tool is therefore an ever-
moving target that has the flexibility to change annually to fit the individual's changing needs.
There are certainly times when investors should be prepared to accept more risk as a tradeoff
against loss of returns. Although somewhat riskier, slightly more volatile investments with de-
creased initial withdrawals may even be the best approach for long-term strategies. Also, the
latitude that is provided regarding mandatory withdrawal amounts is of predominant importance.
Therefore, there is flexibility which is needed when the asset value decreases and the portfolio
experiences fickle cash flows.
RULE: CONSUMERS THAT ARE SHOPPING FOR LIFE INSURANCE POLICIES,
ANNUITIES OR INVESTMENT OPTIONS SHOULD ALWAYS BE EDUCATED
ABOUT THE VARIOUS FEATURES OF THE POLICIES, THE CHARGES THAT ARE
INVOLVED AND THE RISKS INVOLVED BY PLACING THEIR MONEY WITH
INSURERS AND OTHER COMPANIES.
When the consumer makes well-informed decisions and they are satisfied that they are able
to support their investment without the need to make large withdrawals that could endanger their
policies, then the agent can assure the policyowners that they will be able to benefit from the
many financial options and investment instruments that are now available.
Specifically, the following section is offered as the result of various studies and recommen-
dations from various financial and insurance sources.
RECOMMENDATIONS AND ADVISORY NOTATIONS
These recommendations and advisory notations submitted as the result of various studies are
mostly included and discussed within the text, but are placed here for emphasis.
It is obvious that various types of life insurance policies have different prices and perform
differently, therefore prospective policyowners must make comparisons among various insurance
companies based on the level of risk, credited interest rates, surrender/mortality/expense charges,
investment (and other) expenses and fees, and taxes. To be honest about it, except in a very few
94
cases, by this time the prospect is hopelessly lost—which is understandable as many agents are
lost here also.
An agent must do a credible balancing act when presenting the factors that
make up the premium/investment in insurance, so that the prospect will be comfortable
with his final decision,
The balancing" refers to providing the prospect sufficient information so that they can make
an intelligent and informed decision, and still not overwhelm him so that he will make no deci-
sion. If too much information is presented in a short period of time (which is all that most agents
get) the prospect will not make a decision, and often will just call a competitor and ask "What do
you recommend?" When discussing a securities program, the use of the prospectus is invaluable.
Prospects are able to study the investment and feel comfortable knowing that the prospectus is
totally honest as the federal government says it is.
The second stage is to refer the prospect to AM Best, Standard & Poor's, Moody's or some
other source. Most experienced agents will have copies of the latest report from at least one of
the guides, otherwise the prospect may insist on searching for the financial report at the library
(or somewhere) and once he stops and gets sidetracked the agent will probably never see him
again. So—
RULE: ALWAYS CARRY COPIES OF A RECENT REPORT FROM AM BEST OR
OTHER GUIDE ON THE COMPANIES REPRESENTED, AND DISCUSS THE
FINANCIAL STRENGTH OF THE INSURER EARLY IN THE PRESENTATION.
THAT IS A FORM OF "SPEAKING FROM STRENGTH."
If the agent is not a qualified professional planner, it is important that such professional be
available to provide objective and quality advice and to answer questions. If it is necessary to
bring in an expert or professional, bring him in after all the "nuts and bolts" have been discussed
so that his role will be primarily to fortify what has been presented.
Prospective policy and annuity owners must take into consideration several basic items, in-
cluding:
What will the policy or annuity be used for ideally, retirement or for the beneficia-
ries?
Does the buyer understand what it is that he has bought?
Does the buyer know and understand the fees and expenses that need to be paid?
Does the buyer understand the time frame of the plan—how long he has to hold the
annuity before withdrawing money and risk facing surrender charges?
Does the prospective buyer fully understand that the account balance (in certain in-
vestment policies and annuities) will fluctuate in according with investments?
Are the illustrations based on unrealistic assumptions such as those discussed above
(mortality improvement, increased projected rate of return, lower future expense,
dropping out of policyholders leading to persistency bonuses)?
Did the prospective buyer of life insurance policies ask the agent to reassess the pro-
jected performance of the policy by using an interest rate that is one or two percen-
tage points below the current interest rate?
95
RULE: WHEN MARKETING PRODUCTS THAT USE ILLUSTRATIONS, BE
PREPARED TO SHOW THE SAME ILLUSTRATIONS USING ONE OR TWO
PERCENTAGE POINTS BELOW THE CURRENT INTEREST RATE AS SHOWN ON
THE ILLUSTRATION.
Every effort should be made to make sure that the prospect understands the calculations and
the figures involved (as much as is possible).
Replacements and churning—replacements MUST be accomplished only when it will affect
the policyowner positively and he will be in a better position than if he stayed with his present
plan. Take into consideration the early commissions paid (use whatever percentage is paid) by
subtracting it from the early gain and see if the new plan still grows significantly.
Again, repeated over and over, the prospective purchaser of interest-sensitive life insurance,
or Variable Annuities, MUST recognize the risk that they assume by investing in such a product
as their yield can fluctuate and they must be aware of that.
Agents can help avoid liability suits by helping their clientele recognize that illustrations that
are provided are not guaranteed projections of performance of the interest-sensitive policies. The
best way to do that is to provide more realistic figures by using more conservative assumptions.
STUDY QUESTIONS
1. When Universal Life insurance and other interest-sensitive life insurance policies were first
introduced in an attempt to offset the drain of funds from insurance policies to investments
with a higher return, they were an excellent tool, but they had two problems,
A. cost and commission.
B. understandability and cost.
C. replacement and illustrations.
D. definitions and coverages.
2. If an agent asks to replace an existing Whole Life policy with considerable cash value, with
an interest-sensitive policy and he points out that with the rapid growth of the cash value ac-
cording to the presented illustrations, the policy will be paid up within 7 or 8 years. These
policies are known as
A. vanishing premium policies.
B. indexed Universal Life insurance policies.
C. variable annuities.
D. 1035 exchange Whole Life policies.
96
3. The churning and replacing of policies with interest-sensitive plans—Universal Life type pol-
icies primarily—eventually came to an end because
A. states regulated the policies out of existence.
B. insurers stopped paying commissions on replacement policies.
C. of adverse publicity.
D. interest rates started declining.
4. The "churning" scandal is basically settled by now, and it was settled rather rapidly because
A. attorneys were successful and insurers cooperated in paying damages to wronged clients.
B. the states' departments of insurance were pressured by the SEC.
C. the attorneys general of the various states banded together and forced the companies to
pay hefty fines.
D. of bad publicity.
5. One of the actions that could have at least slowed down the replacement rate at its heyday was
that
A. life insurance agents should more often contact their clients after selling the policy.
B. life insurance agents needed to stop servicing their clients so much.
C. clients have become much better educated in insurance matters, thanks to the extended
service provided by (primarily) agents.
D. commissions were much too high.
6. When marketing insurance products, it is always wise to be aware of the financial position
and rating of the insurer and
A. don't breathe a word of the results to the prospect.
B. always inflate the rating somewhat, enough so that you can always claim you misread it.
C. share it with the client.
D. have it printed at the top of the application form and have the client initial it so that there
never will be a question about it in the future.
7. The purpose of an illustration is to disclose how the policy being illustrated will work,
A. and the illustration may be considered as a guarantee.
B. particularly for those who do not understand the policy at all.
C. distinguishing that which is guaranteed and that which is not.
D. and to take the agent off the hook if the results of the policy are not exactly as represented
by the agent.
8. When life insurance is priced, there is always the non-guaranteed hypothetical illustration
A. which is, by law, complete and totally accurate.
B. and then there is reality.
C. upon which the agent's commission is determined.
D. which is derived from the experience of the agent or General Agent.
97
9. Consumers shopping for life insurance, annuities, or other investment options, should always
be educated about the various features of the policy, the charges involved and
A. the method of payment of premiums.
B. the penalties for misrepresenting health conditions on the application.
C. the risks involved in placing their money with insurers and other companies.
D. how to beat the system.
10. A good rule to follow when using illustrations, is to
A. show the same illustrations, using one or 2 percentage points below the interest rate
shown on the illustration.
B. never touch an illustration unless you are prepared to produce voluminous statistics.
C. never leave the illustrations with the consumer.
D. emphasize that the illustrations are guaranteed to be 99% accurate.
ANSWERS TO STUDY QUESTIONS
1C 2A 3D 4A 5A 6C 7C 8B 9C 10A
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Code of Ethics
1. The agent must always act in a professional manner.
2. The agent must ascertain and understand all relevant matters
surrounding the client.
3. The agent must give due consideration to other professionals
serving the client.
4. The agent must not disparage or belittle another agent.
5. The agent must provide advice to meet the needs of the client.
6. The agent must honor the confidential relationship that exists
between the client and the agent.
7. The agent must continue their professional education through-
out their career
8. The agent must obey all laws pertaining to their profession.
9. The agent must conduct their business in such a way as to en-
hance the insurance profession.
99
REFERENCES
The Best of "STRICTLY SPEAKING"
Ethics Readings from the Journal of the American Society of CLU & ChFC
The American College, 1995
INSURANCE QUALITY
How to Improve Quality, Compliance, Customer Service & Ethics in the Insurance
Industry.
Hedy Abrmovits and Les Abromovits
CRS Press, 1998
PRINCIPLES OF PRINCIPLED LIFE INSURANCE SELLING
Ned B. Ricks, CLU
Writers Club Press, 2001
BUSINESS ETHICS – ETHICAL DECISION MAKING AND CASES
Ferrell, Fraidrich and Ferrell
Houghton Mifflin Company, 2005
THE SAVINGS DILEMMA OF TRADITIONAL INSURANCE
Dan Strain, Policyholder.
Trafford Publishing, 2003
INSULT TO INJURY, INSURANCE FRAUD AND THE BIG BUSINESS OF BAD FAITH
Ray Bourhis
Berrett-Koehler Publishers, Inc., 2005
THE HANDBOOK OF ESTATE PLANNING
Robert Esperti & Renno Peterson
McGraw Hill Book Co., NY 2002
100
PRINCIPLES OF INSURANCE PRODUCTION
Peter Kasicky, et al
Insurance Institute of America, 1986
BLACK’S LAW DICTIONARY
West Publishing Company
ANNUITIES
Continuing Education Insurance School
Private Printing 1998
DICTIONARY OF INSURANCE TERMS
Harvey W. Rubin, Ph.D., CLU, CPCU
Barron‘s Educational Series, 1995
Financial and Estate Planning with Life Insurance Products
James C. Munch, Jr.
Little Brown & Co. 1990
LEGAL ASPECTS OF LIFE INSURANCE
Edward Graves and Dan McGill
American College 1997
LIFE INSURANCE
Kenneth Black & Harold Skipper
Prentice Hall 1993
ANNUITIES ANSWER BOOK, 2004 CUMULATIVE SUPPLEMENT
John T. Adney, Joseph McKeever III, Barbara Seymon-Hirsch
Aspen Publishers, 2004
GETTING STARTED IN ANNUITIES
Gordon K. Williamson
John Wiley & Sons 1999
101
ERNST & YOUNG’S PERSONAL FINANCIAL PLANNING GUIDE,
Robert Garner, Robert Coplan, Martin Nissenbaum, Barbara Raasch, Charles
Ratner
John Wiley & Sons, Inc. 1999
EQUITY INDEXED ANNUITIES
Thomas F Streiff, CFP, CLU, ChFC, CFS, Chythia DiBiase, CFS
Dearborn Financial Publishing 1999
Various Sections of the California Insurance Code, particularly the following sections:
10134-10139.5
10489.1-10489.95
10110-10127.18
12919-12938
1871-1871.9
815-816
10089.70-1008983
1067-1067.18
12961-12969
790-189.15
New York Times, Sept. 8, 2007, article "The appeal of annuities has increased.", by Humber-
to Cruz, "The Savings Game."
Other Newspaper articles from the New York Times and the Washington Post, Wall Street
Journal, Best's Reports, and other such printed material,
102